With MSCI China finally breaking above the average 12-month forward PE of the index (11.9x) after six years at 13.5x, it signals that investor confidence is returning to the Chinese stock market.

Does this signal a return of the good old days?

Fundamentals still slightly weak but bullish sentiments driving market

Although MSCI China PE has broken through the average 12-month forward PE, UOB Kay Hian Research (UOBKH) notes that EPS growth and return on invested capital (ROIC) continues to be weak.

MSCI China index only saw a slight improvement in its return on invested capital (ROIC) to 5.8% from a low of 5.5% in 1Q17.

This is far below the average ROIC of 9.3% since 2005. Historically, a ROIC of 5.8% should only support a PE of 10x.

However, the market expects a strong double-digit EPS growth for 2017 and 2018, pushing for a PE re-rating.

Noting the bullish sentiments, UOBKH recommends five Chinese stocks that investors should own.

1. Ctrip

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UOBKH expects Ctrip to be a key beneficiary of the past eight days of national holiday in China, the “Super Golden Week”.

Chinese tourists went on longer trips and taking longer flights, boosting tourist numbers and of course, commission revenue for Ctrip too.

UOBKH notes that the overall fundamental environment remains “favourable” for Ctrip as the increasingly wealthy Chinese tourists’ demands for more travel services.

More demand from higher penetration in tier-2 and tier-3 cities are also adding to the demand for travel services.

UOB Kay Hian Research: Ctrip.Com International Limited (NASDAQ: CTRP) – BUY; Target Price US$62.00

2. New Oriental Education

New Oriental Education’s share price has been on a downtrend over the last few weeks.

Yet, UOBKH sees the recent weakness as a buying opportunity prior to New Oriental Education’s 1QFY18 results.

New Oriental Education should deliver double-digit growth in both revenue and earnings as it announces its 1QFY18 results.

The stock is currently trading at 1.05x PEG, based on an FY17-20F EPS CAGR of 29.4%.

UOB Kay Hian Research: New Oriental Education & Tech Group Inc (NYSE: EDU) – BUY; Target Price US$99.00

3. Tongda

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The recent disappointing iPhone sales led to a correction in the share price of Tongda.

UOBKH believes that investors should be taking a contrarian approach and take a position in Tongda while its share price is at a good entry price.

UOBKH foresees the upcoming iPhone X sales (starting 3 November) to be much more encouraging than iPhone8/8 Plus sales following a “significant facelift and functions upgrade” for the iPhone X.

UOB Kay Hian Research: Tongda Group Holdings Limited (HKG: 0698) – BUY; Target Price HK$2.80

4. China Construction Bank

UOBKH recommends China Construction Bank as its top banking pick due to its “pristine asset quality and lean cost structure”.

China Construction Bank’s core tier-1 ratio at 12.68% remains one of the highest among Chinese banks.

UOBKH notes that China Construction Bank classifies loans that are overdue for more than 60 days as non-performing loans (NPLs), a conservative approach that is desirable.

As such, UOBKH thinks China Construction Bank is trading at an attractive valuation, given its strong fundamentals and a price-book ratio of 0.7.

UOB Kay Hian Research: China Construction Bank-H (HKG: 0939) – BUY; Target Price HK$8.25

5. CSPC

CSPC has successfully transitioned its core business focus from the active pharmaceutical ingredient (API) sector into the lucrative innovative drug industry.

CSPC’s “blockbuster innovative” drug, NBP, currently contributes 23% of total revenue in 1H17.

Moreover, the management built a well-diversified portfolio on oncology drugs, which puts CSPC in a favourable position to capitalise on any upside potential.

UOB Kay Hian Research: CSPC Pharmaceutical Group Limited (HKG: 1093) – BUY; Target Price HK$15.24