The booming Chinese stock market was responsible for up to half the earnings growth of companies listed in Shanghai and Shenzhen duirng the first six months of 2007 - a worrying trend that analysts say will exacerbate any market downturn.

Profits increased on average 71 per cent in the first half for the more than two thirds of listed Chinese companies that have published results. But profits from core operations increased at about 35 per cent, reckons Jerry Lou, equity strategist at Morgan Stanley: "I don't think the market fully appreciates that half of the current earnings growth is a one-off thing . . . "


Non-operational income at listed Chinese companies accounted for only 13 per cent of total profits in 2006. That rose to 31 per cent in the first half for the 900 or so companies that have reported earnings so far, according to Morgan Stanley. The proportion is much higher than most developed markets where non-core income usually accounts for less than 10 per cent of total profits.

Chinese companies and investors have been tempted by a market up more than 90 per cent for the year and more than five-fold since July 2005.

"The sort of cross-holdings in the market means profits are often counted twice," said Ed-mond Huang, China A-share strategist at UBS. "If the market turns down, or even levels off, then earnings will evaporate and this investment strategy will backfire."

Some domestic investors have pointed to strong earnings growth to justify valuations higher than elsewhere in Asia.

By Friday Chinese companies listed in Shanghai and Shenzhen were trading at an average 38 times 2007 estimated earnings, against an average price to earnings ratio of 22 times in Hong Kong.

Financial companies derived 26 per cent of first-half profits from non-operational income; up from 8 per cent in 2006, Morgan Stanley stimates.

First-half profits at Ping An Insurance jumped 140 per cent, thanks largely to its stock market investments. Last week Industrial and Commercial Bank of China said profits rose 62 per cent. China Construction Bank at the weekend reported a 47 per cent gain in profits.


China Life Insurance on Monday said first-half net profit more than doubled to Rmb23.29bn ($3.08bn) on investment gains.