Guosen's Xun Yugen: DDM Model Suggests A-Share Upside Potential, Three Factors Support

Author: Xun Yugeng, Chief Economist and Director of the Economic Research Institute at Guosen Securities, and Member of the China Chief Economist Forum

Key Conclusions

• Earnings: A-share net profit is growing at a double-digit rate year-on-year.
• Risk-Free Rate: The decline in the 10-year government bond yield this year is favorable for long-term capital inflows.
• Risk Appetite: While global risk appetite has risen this year, A-share risk appetite remains below its historical average.

Understanding the Divergence Between A-shares and Global Markets

Recent market sentiment among A-share investors has been subdued. The CSI 300 and the Shanghai Composite Index have declined year-to-date, while previously strong indices such as the STAR 50 and the ChiNext Index have seen their gains significantly narrowed. In contrast, overseas equity markets and risk assets such as crude oil and copper have posted considerable gains.

To understand this divergence between A-shares and overseas equity and commodity markets, it is useful to return to the fundamentals of asset pricing and analyze the situation through the lens of the Dividend Discount Model (DDM).

According to financial theory, the fair price of a stock should equal the present value of its future cash flows. This is captured by the DDM model:

Under a constant dividend payout ratio, the numerator reflects earnings, while the denominator (the discount rate) primarily reflects the risk-free rate and the risk premium.

Below, we analyze the three key factors driving stock prices.

1. Earnings: Double-Digit Year-on-Year Net Profit Growth

A-share net profit has grown at a double-digit rate year-to-date. Earnings improvement is the most significant positive change in the A-share market this year, and the breadth of this improvement is expanding.

• Overall Data: Net profit growth for all A-shares improved markedly in the first half of the year. China's real GDP grew by 4.7% year-on-year in H1. Corporate earnings showed greater resilience. The year-on-year growth rate of net profit attributable to parent companies for all A-shares was only 2.0% in 2025 (and -2.8% excluding financials), but rebounded to 15.9% (and 15.1% excluding financials) in H1 2026. Meanwhile, the ROE (TTM) of all A-shares in Q2 2026 rose for the first time since 2022.
• Sector Breakdown: The technology sector posted the fastest earnings growth. Based on semi-annual reports, the technology sector, led by electronics, achieved the highest net profit growth, with a cumulative year-on-year growth rate of 101% in H1. The breadth of fundamental improvement is also expanding. Using the proportion of Shenwan secondary industries with net profit growth exceeding 10% as a measure, the breadth of profit improvement across all A-shares increased from 38% in Q4 2025 to 46% in Q2 2026.

2. Risk-Free Rate: Decline in the 10-Year Government Bond Yield

The decline in government bond yields this year is conducive to long-term capital entering the market. Domestic investors typically view the 10-year government bond yield as a proxy for the risk-free rate, which influences stock prices through the discount rate in the DDM model's denominator.

• Yield Movement: The 10-year government bond yield has fallen this year. It has declined by 16 basis points from 1.9% at the beginning of the year to 1.7%. The supply of government bonds has also decreased compared to the same period in 2025, and the backdrop of an "asset shortage" may have further pushed down long-term rates. Although overseas interest rates have risen recently, the impact on domestic risk-free rates is likely limited. The central tendency of the 10-year government bond yield for the full year is expected to shift downward.
• Impact on Insurance Funds: Against the backdrop of lower interest rates, the scale of equity allocation by insurance funds is expected to continue expanding this year. As bond yields decline, future investment returns on bonds are compressed, making equity assets more attractive. Retail investors, insurance funds, and private equity funds have all entered the market on a considerable scale this year. Insurance funds are a major force, with net inflows reaching RMB 479.5 billion in H1 (see table below).

Looking ahead, supported by growth in insurance premium income and a new regulation requiring listed state-owned insurers to allocate 30% of their annual new premiums to equity assets, insurance funds are expected to further increase their equity allocation this year, providing support for market liquidity.

3. Risk Premium: Global Risk Appetite on the Rise

Global risk appetite has increased this year, and A-share sentiment is expected to recover eventually. According to the pricing model, risk appetite also affects the discount rate in the denominator. The significant positive returns of overseas equities and commodities this year indicate a rise in global investment sentiment.

• Global Market Performance: Overseas stock markets and commodity markets have risen notably year-to-date (as of September 16). Japanese and South Korean markets have led the gains, U.S. stocks have risen by double digits, and UK and German markets have also advanced. Only A-shares and Hong Kong stocks have seen broad-based index declines. In the commodity market, crude oil and copper have led the gains, rising by 79% and 12%, respectively. Risk premium indicators for the U.S., Japan, and South Korea show that risk appetite has been rising this year and is at high levels relative to the past 15 years.
• A-share Sentiment: A-share market sentiment is currently weak but is expected to recover within the year. Trading activity has been subdued recently. The five-day moving average of total A-share turnover has fallen from RMB 3.55 trillion in late June to less than RMB 1.75 trillion, a decline of over 50% from the peak. The current risk premium for all A-shares is 3.0%, placing it at the 31st percentile from the top since 2005. Looking back at the bull markets of 2019–2021 and December 2012–June 2015, the risk premium at market peaks reached near the mean plus one standard deviation. This time, it has not even reached the mean. Compared to historical levels and other global risk assets, the current risk appetite for A-shares is low and has potential to rise.

Conclusion

Based on the DDM pricing model, A-share net profit has grown significantly this year, the decline in the risk-free rate is favorable for capital inflows, and market risk appetite is expected to recover. These three factors support a positive outlook for A-shares this year.

We have consistently compared the market rally that began on September 24, 2024, to the "519 rally" of 1999. The common backdrop is an economy undergoing a transition between old and new growth drivers. In terms of market rhythm, the current phase is similar to late February 2001. From a wave theory perspective, the market is currently at the low point of a fourth-wave correction and the early stage of a fifth-wave advance.

Risk Warning: Fundamental improvement may falter; geopolitical events could impact market sentiment.

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