The biggest risk to hold Chinese stocks, taking Alibaba and Tencent as examples

Chinese stock

Recently I talked to many friends about the crash of Chinese stocks; many investment friends wrote to me mentioning this important topic ─ It can be seen that this is a topic that most U.S. stock investors are very concerned about. First of all, please refer to my other blog article “Why do many Chinese companies want to go public in the United States?“, to understand the reasons why Chinese companies went public in the United States.

Chinese stock

The government has the final say

In China, the government has the final say. It is difficult for companies to have room for appeals, and it is difficult for companies to protect their own rights and interests. This is the biggest risk of holding Chinese stocks. The media once reported that Jack Ma had indicated to the Chinese government that he was willing to hand over the Ant Group to the government if necessary.

In contrast, let’s look at the United States. The United States is basically a country under the rule of law. Even if the government imposes compulsory sanctions on companies, companies can appeal, seek relief from the courts or seek opportunities for reversal. The following are a few of the more influential and well-known turnaround cases in recent years:

  • The Federal Trade Commission (FTC) ruled that Facebook (ticker: META) monopoly was established, requiring Facebook to sell WhatsApp and Instagram. Facebook was dissatisfied and appealed repeatedly, and the US Supreme Court finally ruled that the case was not established and closed in April 2021. However, the FTC decided to go with Facebook to the end, and to raise antitrust litigation in August 2021 again.
  • The FTC filed Qualcomm’s antitrust case in 2017. Qualcomm (ticker: QCOM) repeatedly appealed and was once found to have monopolistic facts, but it was rejected. At the end of March 2021, the Federal Trade Commission finally decided to abandon the appeal and no longer continue the case.
  • Apple (ticker: AAPL) resisted repeated requests from the U.S. government and the FBI to force Apple to unlock the suspect’s iPhone. This incident, on the contrary, carried out free publicity for Apple. Since then, Apple has established itself as the protector of user privacy and established Apple’s position in the minds of customers. For details, please refer to my other blog article “Why is Apple’s privacy policy so important?
  • In 2019, Amazon (ticker: AMZN) complained about Trump’s prejudice, which affected the decision of the Department of Defense to allow Microsoft (ticker: MSFT) to obtain a $10 billion Jedi cloud contract. Amazon and the U.S. government fought a two-year lawsuit. In 2021, the court ruled that the Department of Defense must re-tender. In the new JWCC of the US Department of Defense, the cloud contract is changed to an irregular delivery/undefined quantity (IDIQ) contract that is responsible for multiple companies. Currently, Microsoft and Amazon are only allowed to make proposals.
  • Since 2014, Microsoft has for many years resisted the US government’s request that Microsoft must hand over the email content of international users. So far Microsoft has been reluctant and unwilling to cooperate. In 2021, Microsoft also accused the U.S. government of abusing power: law enforcement agencies secretly obtain customer data without demand; and Microsoft’s accusation also won the general support from major technology peers.

The importance of regulation

As I mentioned in my book “The Rules of Super Growth Stocks Investing” section 4-1, government regulation is one of the important factors that affect stock prices. The biggest difference between government regulation and other factors is that government regulation is a factor that companies cannot control by themselves. It has the greatest killing power. Basically, it has coercive force on all companies in the industry. In history, there is no shortage of companies and even the entire industry gone because of the government. The supervision was greatly damaged, and even disappeared.

What happened

The matter should have started when Alibaba’s Ant Group was suspended the day before its IPO in October last year.

  • For details of the antitrust law, please refer to my other blog article “Antitrust and governance faced by Chinese and American technology giants
  • Online lending must be split by technology groups and returned to banking system supervision.
  • The policy of double reduction in education prohibits after-school tutoring and the listing of tutoring companies. On the day of the policy disclosed, New East (ticker: EDU) plunged 54.22%, TAL Education (ticker: TAL) plunged 70.76%, and Gaotu Techedu (ticker: GOTU) plunged 63.24%.
  • Consumers forced to choose one of two platforms.
  • Didi (ticker: DIDI) asked to postpon its IPO due to Chinese regulators’ requirements, but Didi insists on going public in the United States, triggering regulation of user data privacy. After the stock went public, it fell all the way, falling 42% in only two months.
  • Encourage U.S. listed Chinese stocks to return to Hong Kong for dual listing.
  • In the future, Internet companies with a large amount of sensitive data will go public in the United States and must strip off sensitive data to third-party companies.
  • The Central Committee of the Communist Party of China advocated “common prosperity” and said goodbye to Deng Xiaoping’s proposal that “have few people get rich first”. I think this item is the most important. All the CCP’s major ruling principles and necessary supervision will be carried out based on this guideline. Let’s wait and see.
  • Rectify the complicated official-business relations between Hangzhou officialdom and Alibaba Group.
  • Ban artists’ cheating contracts.
  • Minors are restricted to three hours of video games on holidays.

If you look carefully, the target is no longer limited to the technology industry. This series of actions should not end in the short term, and there may be new regulatory measures to be introduced; this has caused the Chinese stocks of Hong Kong and US stocks fall for more than half a year. In the meantime, China also convened important foreign legal entities to appease investors, emphasized that it would protect investors and that the opening of the market would not turn back, defended the recent supervision.

China is currently the world’s largest foreign trade country and the second largest GDP (no one doubts that it will become the first in ten years. For details, please refer to my other blog article “The importance of the Chinese Market: more than 10% of U.S. listed companies, 14.98% of Taiwanese companies income comes from China“). With China’s current economic achievements, the complexity and key position of the international supply chain, the degree of openness of the market, and a reasonable estimate, it is impossible to return to the previous closed-door policy before the opening in the 1970s. The problem is that no one knows when this wave of new regulatory policies will end.

Views on Chinese Stocks

Earlier, I mentioned my views and reasons for Chinese Stocks in section 3-6 of my book “The Rules of Super Growth Stocks Investing”. For retail investors, unless you have a “very special” reason, you don’t have to buy Chinese stocks. There are nearly 12,000 companies in the U.S. stocks that can be considered for trading. Of course, we are more familiar with Chinese stocks (because of the Chinese language and cultural relations) than the Americans, but the investment is to make money. The probability of success and risks must also be considered. The competitiveness of individual companies is more important. Investors should not have any preferences or prejudices. It is more important to make money.

Valuation of Chinese stocks is much lower than U.S. peers

Twenty years ago, the valuation of Chinese stocks was usually not lower than that of the United States, and some of them were higher than their peers in the United States. At that time, China’s reform and opening up began to see results, and China began to grow rapidly at an astonishing economic growth rate of more than 10% per year. American investors have high expectations of a huge market. In addition, at that time, the United States did not regard China as a threat, and the two sides were in the best honeymoon period.

China Mobile (ex-ticker: CHL) and Baidu (ticker: BIDU) are two well-known examples. Both of these companies gave very high valuations on US stocks in the early days of their listing. Since 2015, Baidu has been complaining that the valuation given by American investors is too low, and has repeatedly threatened to go back to the Chinese market for listing. As for China Mobile, in 2021, it was finally forced by the US government to go off the market and return to China for listing.

But the good times are no longer. After the 2008 financial crisis, China suffered less damage and its national strength greatly increased. The United States began to regard China as the only threat. Since then, the valuation of Chinese stocks listed on US stocks has begun to be lower than that of their American counterparts. In the Trump era, this kind of competition has intensified. The chairman of the SEC even publicly asked Americans not to buy Chinese concept stocks on TV. This year, the situation has worsened. The SEC has announced that if Chinese stocks cannot be audited, and if Chinese stocks cannot be separated from the government, it will prohibit Chinese stocks from listing in the United States in the future.

Stock priceP/SP/EMarket Vale (in US$ trillion) Annial revenue (in US$ million) Revenue growth rateDrop from year high
Alibaba 165.240.5719.250.436131109,46852.11%50.06%
Amazon3349.633.8358.371.696 386,06437.62%11.22%
Tencent58.961.0719.730.4478 73,847.9
36.39%40.68%
Facebook372.6310.0327.631.051 85,96521.6%1.3%
Alphabet2880.088.7428.861.926 182,52712.77%0.35%

After reading this table, investors who invested in Alibaba (ticker: BABA) and Tencent (ticker: TCEHY) must feel aggrieved, because the same business is not worse in all aspects; the revenue scale and revenue growth are even better than the counterparts in the U.S. Why are the valuations given by U.S. stocks market to Alibaba and Tencent far lower than those in the U.S. peers? The gap is too great; it can only be expressed in terms of the distance between them. But there may be some people who will immediately refute it because of the sharp drop in Chinese stocks in the past six months. To whom hold this view, I would suggest you to check the valuation comparison at the beginning of this year, you will not have this view. The valuation of Chinese stocks such as Alibaba and Tencent by U.S. stock market has always been much lower than that of their American counterparts. This is a phenomenon of “long-term” unfair valuations, and it has not only happened to Alibaba and Tencent.

From another perspective, even Alibaba and Tencent, the two largest technology companies in China, have been treated with such valuations, not to mention other companies. Please note that the market value of Alibaba and Tencent was not lower than that of Facebook more than half a year ago. After more than half a year of development, the U.S. peers have risen a lot, back and forth; now both Alibaba and Tencent have less than half the market value of Facebook!

How terribly fell

Regardless of political factors, the share prices of Alibaba and Tencent have been sold to an incredible and unreasonable level. The reasons are:

  • Basically, Alibaba and Tencent are world-class companies at the same level as the top five technology companies in the US stock market, and their valuations should be compared with these five. Take Alibaba as an example. Alibaba’s current cash position is about 17% of the current market value, which is obviously unreasonable.
  • Alibaba’s stock price has fallen by more than 50% from its highest point, while Tencent’s stock price has fallen by more than 40% to its highest point, both of which are the largest share price declines in the history of the two companies.
  • During this wave of over-selling for more than half a year, most institutional investors and retail investors almost stood as sellers, and there were very few reverse operators. However, the sovereign funds (please see my blog article “Sovereign Wealth fund“) of various countries related to the country are buying all the way, because the investment of sovereign funds is a long-term layout, and all have comprehensive political and economic considerations. The world’s largest Norwegian sovereign fund has a net worth of US$ 1.275 trillion by the end of 2020, while Alibaba is the 10th largest holding, and Tencent is the 11th largest holding. The fund holds shares in 742 Chinese companies, and the stock market value has increased by 35.75% annually, with a scale of more than RMB 320.5 billion.

A better strategy for most people

For conservative or ordinary investors, if you have a China concept stock that you “have held for a long time and has performed well”, I personally recommend you to keep it, because the stock market will reflect their true intrinsic value sooner or later. Unless you are confident (in the current situation, it will be very difficult for average investors), do not buy any new Chinese stocks. The reason is simple; the prospects are unclear, and the existing regulatory measures in China will not end in the short term. Worse still, there is a high possibility that new regulatory measures will be launched again because of this wave of regulatory measures in China. It is clear that it is not a single department, a single direction, a single industry, a single purpose, and short-term actions, but a planned long-term and comprehensive supervision measure – this is what is worth worrying about.

More active plan

If you have a good grasp, you have different thoughts or insights from average people for individual companies in mainland China. If you firmly believe that “you should give up your children or can’t get wolves”, then you can adopt a more active investment strategy:

  • Now that the Chinese stocks listed on the US stock market have fallen sharply, it is a rare opportunity of once in a generation crash. In fact, it is worse than that. Because of the crash in March last year, it is impossible for Chinese stocks to fall to such a price.
  • You can invest part of the capital to test the price. If it is the same as your inference, plus the necessary patience, then you will be able to get a considerable reward. In particular, if it is a Chinese stock on your long-term watch list, I believe you will be more certain.
  • In this move, the well-known investor Duan Yongping is an active investor that we are talking about here. Duan Yongping has been following Tencent for a long time, and in 2018, when the stock price fell due to the regulation of the game version number, he made a substantial increase in buying. The current decline, of course, he admitted to the outside world also entered the market to grab the bargain.
  • In addition, Munger is optimistic about Alibaba for a long time. Buffett and Munger have expressed to the media many times that they regret not buying Alibaba. He also took advantage of the plunge in Alibaba’s stock price to buy Alibaba. This is not surprising at all, because he has tracked Alibaba for a long time, and when he believes that the stock price has become more attractive due to a sharp drop, he will certainly seize this opportunity. Bridgewater Ray Dalio (also Buffett and Munger) is a long-term investor who is optimistic about China’s future prospect. It is no surprise that he will take advantage of this to plunge into the market.

Oct. 2021 disclosed, Munger’s Daily Journal (ticker: DJCO) now has about 18% of Daily Journal’s portfolio in Alibaba, at a basis of between $180 and $200 per share.

Conclusion

We don’t have to dance with the masses and be affected by the American and Taiwan government’s anti-China actions, or mainland China’s regulatory measures; these are all prejudices and bias, and the competitiveness of individual companies is more important than these. Next time if you are thinking about buying China concept stocks next time, please remember to come back and read this article, I hope this article of mine will help.

  • The regulations and laws of the United States and China are very different. Always remember that “In China, everything is the government’s final say. It is difficult for companies to have room for appeal, and it is difficult for companies to obtain protection for their rights and interests.” Can you bear such risks?
  • Are the Chinese stocks you want to buy better or more competitive than Alibaba and Tencent? Can you get a better valuation than Alibaba and Tencent?
  • Revisit my content of section 4-1 in book “The Rules of Super Growth Stocks Investing”.
  • There are nearly 12,000 companies in the U.S. stocks that can be considered. Why do you have to choose this Chinese stock? Why not just buy this company’s American counterparts?

Disclaimer

  • The content of this site is the author’s personal opinions and is for reference only. I am not responsible for the correctness, opinions, and immediacy of the content and information of the article. Readers must make their own judgments.
  • I shall not be liable for any damages or other legal liabilities for the direct or indirect losses caused by the readers’ direct or indirect reliance on and reference to the information on this site, or all the responsibilities arising therefrom, as a result of any investment behavior.

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