Profitability of Chinese companies

Economist has an interesting account on the profitability of Chinese companies, which also discussed the counter-points raised by private equity Newbridge Capital's Weijian Shan.

Very interesting data and views, a couple caveats on the study (which in general supports the Economist's views)

1. the study focuses on comparing the profitability listed companies in China vs other countries, which is a good control test. However, one should bear in mind that a) in developing countries such as China, legal, tax and accounting enforcement is not as established; b) the (transparency) gap between public and private companies are wider in countries like China
2. There are more leeways for Chinese companies to report lower than real profit, especially from 2001-2005, so that the valuation is lower when shares are sold to the management
3. The common deal between local government and major local companies are to inflate revenue and under-report profit, so that the local official has high GDP (affects their promotion). This would increase the VAT payable and decrease the profit tax by the companies. There would be deals of tax rebates to the companies (local government receives some split of the tax, usually 1/3) for "tax equalization" (what was called subsidies are in fact tax rebate for equalization, so these are real operating profits)-- this could mean that profits are under-reported and that the crackdown by the central government on these scheme may have led to profit increase (truer figures) in 2005/06

I am not surprised by the results. Even mediocre companies would see profit growth in a booming economy, simply because of the enlarged scale. I would be very surprised if the profitability did not improve when the GDP has been growing at around 10% over the years.