Morgan Stanley launches China Best Business Models V2, focusing on 26 high-quality Chinese companies
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Morgan Stanley launches China Best Business Models V2, focusing on 26 high-quality Chinese companies
Using fundamental, quantitative, and thematic research frameworks, the report screens 26 Chinese listed companies with durable competitive advantages; backtests indicate the portfolio's ROE is about 1.5x MSCI China and that it delivered higher risk-adjusted returns.
- China BBM V2 includes 26 companies across 16 industry groups, with an emphasis on structurally growing areas such as Information Technology, Industrials, and Materials.
- The backtest shows a dollar-denominated equal-weight portfolio total return of 101% since February 9, 2023, versus 18% for MSCI China; over a 12-month horizon, the portfolio returned 59% versus 3% for the index.
- The portfolio's 2026E average ROE is 17.4%, about 1.5x the benchmark; its 12-month forward P/E is 14.4x and P/B is 2.5x.
- The stock-selection framework adds AI exposure, Morgan Stanley's four global themes, and a more active sector allocation, emphasizing companies that enable AI, adopt AI, or are less affected by AI.
Report interpretation
Overview
This report is the second edition of Morgan Stanley's China equity strategy team's China Best Business Models, aimed at identifying Chinese listed companies with sustainable competitive advantages, high ROE, and the ability to command valuation premiums in a high-turnover, momentum-driven market where leadership changes rapidly. It combines fundamental analyst judgment, quantitative factors, strategy views, and thematic research to build a concentrated portfolio of 26 high-quality stocks.
Core views
The core view is that companies in China with strong business models, high profitability, reasonable valuations, and structural growth exposure can still generate persistent alpha in the medium term. China BBM V2 is clearly tilted toward Information Technology, Industrials, and Materials relative to the benchmark, while also incorporating the four global themes of AI diffusion, the future of energy, a multipolar world, and societal shifts. The report argues that these companies have stronger earnings quality, greater return resilience, and higher long-term allocation value in areas such as policy support, supply-chain security, technology diffusion, and the energy transition.
Analysis framework
The report first runs quantitative backtests across an investment universe of nearly 700 Chinese and Hong Kong stocks, covering factors such as deep value, current value, capital usage, profitability, growth, momentum, earnings estimate revisions, and risk; it then uses a two-stage screen to assess quality first and valuation second; finally, Greater China sector analysts make the final inclusion decision based on competitive advantages, management quality, geopolitics, regulatory risk, AI adaptability, and thematic fit.
Methodology notes
Two-stage quality and valuation screen
In the first stage, companies within each GICS sector are ranked by profitability, capital usage, and risk; in the second stage, valuation metrics are added, including historical P/B, cash/market cap, EV/Sales, EV/EBITDA, and FCF yield.
Mapping to four global themes
The portfolio selection is aligned with the four themes of AI & Tech Diffusion, Future of Energy, Multipolar World, and Societal Shifts to identify more durable structural opportunities.
AI enablers, AI adopters, or less impacted by AI
China BBM V2 selects only companies that enable AI, adopt AI, or are relatively insulated from AI disruption, and excludes companies facing higher structural uncertainty from AI, especially some online services companies.
Active sector allocation
Rather than strictly anchoring to benchmark weights, the report actively increases exposure to sectors such as Information Technology, Industrials, and Materials based on long-term earnings trajectories, policy support, and strategic relevance.
Asset mapping & comparison
Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).
- China BBM V2 equal-weight equity portfolioCore research object
- Strengths
- High profitability, ROE about 1.5x the benchmark, strong backtested risk-adjusted returns, and relatively high average upside to target prices.
- Weaknesses
- The portfolio is highly concentrated, and the backtest is a hypothetical historical result that cannot represent future performance.
- Comparison
- The report shows total returns since 2023 of 101% versus 18%, 12-month returns of 59% versus 3%, and a 3-year Sharpe Ratio of 1.16 versus 0.32.
- Risks
- Historical backtests are not predictive of future results; active sector deviations and concentrated holdings may amplify volatility.
- MSCI China All Shares IndexStock-selection benchmark
- Strengths
- More comprehensively reflects the opportunity set across Chinese A-shares, Hong Kong-listed shares, and U.S.-listed Chinese stocks; A-shares are treated with an assumed 100% inclusion factor.
- Weaknesses
- A traditional index structure may understate the representation of some A-shares and structurally growing sectors.
- Comparison
- The report argues that this index is a better benchmark for China-wide stock selection than MSCI China.
- Risks
- Changes in index sector weights and shifts in market style will affect relative performance judgments.
- Information Technology, Industrials, MaterialsActively overweighted areas
- Strengths
- Benefit from hard technology, high-end manufacturing, domestic self-sufficiency, supply-chain resilience, and long-term earnings growth.
- Weaknesses
- Valuation, the pace of policy execution, and external technology restrictions may create volatility.
- Comparison
- The report notes that these industries have seen their weights in MSCI China All Shares rise in recent years, and BBM V2 increases their allocation relative to the benchmark.
- Risks
- Geopolitics, export controls, cyclical swings, and lower-than-expected returns on capital expenditure.
Key data
- Number of portfolio companies26Covers 16 industry groups.
- Total backtested return since 2023-02-09101%MSCI China returned 18% over the same period, implying roughly 8,300 bps of relative alpha.
- 12-month backtested return59%MSCI China returned 3% over the same period.
- 3-year Sharpe Ratio1.16The benchmark 3-year Sharpe Ratio was 0.32; the report also discloses 1-year and 5-year figures of 2.51 and 0.53, respectively.
- 2026E average ROE17.4%About 1.5x MSCI China.
- 12-month forward P/E14.4xAbout a 32% premium to MSCI China at 10.9x, and in the 65th percentile of the 5-year range.
- P/B2.5xAbout a 58% premium to MSCI China at 1.6x, and in the 98th percentile of the 5-year range.
- Average upside to target prices37.9%Median upside is 36.7%.
- Rating distribution24 Overweight, 2 Equal-weightBased on Morgan Stanley analysts' relative ratings across sector coverage.
Impact & implications
For investors, the report provides a China equity candidate portfolio centered on quality, profitability, valuation discipline, and structural themes rather than simply replicating index weights. Its investment implication is that, amid sector reconfiguration in the Chinese equity market, AI disruption, policy direction, and global supply-chain restructuring, companies with resilient business models and long-term growth trajectories may be better suited for medium- to long-term allocation.
Risks
- Backtested performance is only a hypothetical mathematical example, and past performance does not guarantee future results.
- The portfolio is highly concentrated in 26 companies, and active stock selection and sector deviations may create higher relative volatility.
- AI-related business-model disruption may be more severe than the current classification framework suggests, especially for online services and labor-intensive sectors.
- Geopolitical tensions, regulatory changes, supply-chain constraints, and dependence on government approvals may affect the competitive advantages of some companies.
- Valuation premiums are elevated; if ROE advantages or earnings growth fail to meet expectations, valuations may come under pressure.
- Morgan Stanley discloses that it may have business relationships with covered companies, so research objectivity may be subject to potential conflicts of interest.
What to watch
- The continued outperformance and drawdown profile of China BBM V2 constituents relative to MSCI China.
- Whether 2026E-2027E ROE, earnings growth, and cash flow can support the current valuation premium.
- Further changes in Information Technology, Industrials, and Materials in policy, earnings, and index weighting.
- How differentiated the earnings outcomes are for AI enablers, adopters, and protected companies.
- The impact of the four global themes, especially AI & Tech Diffusion, Future of Energy, and Multipolar World, on order flow, capital expenditure, and margins for constituents.
- Risk exposure from geopolitics, regulatory policy, and supply-chain security for the selected companies.