Guosen Securities: Three DDM Factors Support A-Share Rally This Year

Recent sentiment in the A-share market has been subdued. The CSI 300 and Shanghai Composite Index have declined year-to-date, while gains in previously strong indices such as the STAR 50 and ChiNext have narrowed significantly. Meanwhile, overseas equity markets and commodities such as crude oil and copper have performed well.

According to financial theory, the fair price of a stock should equal the present value of its future cash flows, as captured by the Dividend Discount Model (DDM):

\[ \text{Stock Price} = \frac{\text{Dividend per Share}}{\text{Discount Rate} - \text{Growth Rate}} \]

Under the assumption of a constant dividend payout ratio, the numerator reflects earnings, while the denominator—the discount rate—primarily reflects the risk-free rate and the equity risk premium. Below, we analyze the three key factors driving stock prices.

1. Earnings: Double-Digit Net Profit Growth

A-share companies have posted double-digit net profit growth year-to-date. Earnings improvement is the most significant positive change in the A-share market this year, with the breadth of earnings recovery expanding.

• In the first half of the year, the net profit growth rate of all A-share companies improved markedly.
• China's economy grew at a moderate pace, with real GDP up 4.7% year-on-year in H1.
• Corporate earnings showed stronger recovery elasticity: full-year 2025 net profit attributable to shareholders grew only 2.0%, and excluding financials, it was negative at -2.8%. In H1 2026, these figures rebounded to 15.9% and 15.1%, respectively.
• In Q2 2026, the ROE (TTM) of all A-shares rose for the first time since 2022.

By sector, technology companies recorded the fastest earnings growth, and profit improvements are broadening. Based on semi-annual reports, the electronics sector led the gains.

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

The decline in government bond yields this year is conducive to long-term capital inflows. 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.

• The 10-year government bond yield has fallen 16 basis points from 1.9% at the start of the year to 1.7%.
• The supply of government bonds this year has also decreased compared to the same period in 2025, and the "asset shortage" backdrop may have contributed to lower long-end yields.
• Although overseas interest rates have risen recently, the impact on domestic risk-free rates may be limited. The central tendency of the 10-year yield is expected to decline further for the full year.

Against this backdrop, insurance funds are likely to continue expanding their equity allocation. As bond yields fall, future returns on bonds are compressed, making equities more attractive. This year, retail investors, insurers, and private equity funds have all contributed significant capital inflows. Insurers have been a major force, with net inflows of RMB 479.5 billion in H1.

Looking ahead, supported by growth in insurance premium income and new regulations requiring state-owned listed insurers to allocate 30% of annual premium growth to equities, insurance funds are expected to further increase equity allocations, providing liquidity support to the stock market.

3. Risk Premium: Rising Global Risk Appetite

Global risk appetite has risen 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. Overseas equities and commodities have posted significant positive returns year-to-date, indicating heightened global investment sentiment.

• As of September 16, Japanese and South Korean stock markets led global gains, with U.S. stocks rising by double digits. UK and German markets also advanced. Only A-share and Hong Kong broad-based indices declined.
• In commodities, crude oil and copper led with gains of 79% and 12%, respectively.
• Risk premium indicators for the U.S., Japan, and South Korea show that risk appetite has continued to rise and is at multi-year highs.

In contrast, A-share sentiment remains weak but is expected to improve within the year. Recent trading activity has been subdued:

• The five-day moving average of total A-share turnover fell from RMB 3.55 trillion in late June to below RMB 1.75 trillion, a decline of more than 50% from the peak.
• The current risk premium for all A-shares stands at 3.0%, at the 31st percentile from the top since 2005.
• During 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. Currently, it has not even reached the mean.
• Compared to historical levels and other global risk assets, A-share risk appetite is low and has room to rise.

Conclusion

Based on the DDM pricing model, three factors support a potential rally in A-shares this year:

1. Significant net profit growth
2. Declining risk-free rates, which encourage capital inflows
3. Potential recovery in market risk appetite

We continue to draw a parallel between the current market, which began with the September 24, 2024 rally, and the "519 rally" of 1999. In both cases, the broader context is an economic transition from old to new growth drivers. In terms of market rhythm, the current phase resembles late February 2001. From a wave theory perspective, the market is likely in the late stage of a fourth-wave correction and the early stage of a fifth-wave advance.

Risk Warning: Fundamental improvement may fall short of expectations, and geopolitical risks could affect market sentiment.

Source: Guosen Securities