Are Chinese stocks suitable for long-term investment?

Chinese stock

I have previously written two articles on the theme of China concept stocks: “The biggest risk to hold Chinese stocks, taking Alibaba and Tencent as examples“, and “Why do many Chinese companies want to be US listed?“. The first article was the third most read article in the English version of this blog last year, and it was also ranked in the top 15 in the Chinese version of this blog. Too many friends are very interested in this topic. After nearly a year, I want to emphasize my opinion again, so I wrote this article you are seeing now.

U.S. does not welcome Chinese stocks

U.S. regulation and deliberate suppression

After the Trump administration era and the continuous purges continued by the current Biden, it is difficult for a large-scale Chinese company to be legally allowed to operate in the United States. And every few days, it is reported that in the name of national security, companies in mainland China are ordered to withdraw from the United States, and hundreds of important Chinese companies are blocked together with allies of the United States. Now almost all the not-so-small-scale Chinese companies are in the United States’ banned and embargoed list. The U.S. is still the world’s largest market for most commodities, and without the U.S. market, the profits of Chinese companies will plummet.

US goverment-sponsored funds not allowed to invest Chinese companies

Trump ordered the U.S. federal pension fund to withdraw from China, and proposed a blacklist of investment bans to list many well-known Chinese companies; Biden expanded the blacklist to prohibit investment in 59 well-known Chinese companies. According to statistics at the end of the first quarter of 2022, US institutional investors currently have investment exposure to Chinese ADRs of about US$200 billion. On April 22, 2020, Jay Clayton, Chairman of the U.S. Securities and Exchange Commission (SEC), warned U.S. stock investors in an interview with Fox Business Network that Chinese companies continue to have problems with public information, and they are investing It is advisable to exercise caution when investing in company shares.

US Legislation Forces Chinese Companies to Disclose Information

In May 2020, the U.S. passed a bill requiring companies to prove they are not controlled by a foreign government, a rule that could lead to a ban on mainland Chinese companies from listing on U.S. stock exchanges. Because China has long opposed the long-arm jurisdiction of the United States over China, the PCAOB (the American Public Company Accounting Oversight Board) is not allowed to conduct audits of Chinese companies.

In September 2021, the chairman of the US SEC announced that if the PCAOB is not allowed to conduct on-the-spot audits of the accounting working papers of Chinese companies listed on the US stock market, 270 Chinese stocks will be forcibly delisted; and the United States is further considering legislation to introduce a grace period. Reduced from three years to two years.

In March 2022, the SEC announced that BeiGene (ticker: BGNE), Yum China (ticker: YUMC), Zai Lab (ticker: ZLAB), HUTCHMED (ticker: HCM), Shengmei Semiconductor, Weibo (ticker: WB), Baidu (ticker: BIDU), iQiyi (ticker: IQ), Futu Holdings (ticker: FUTU), Nocera (ticker: NCRA), CASI Pharmaceuticals (ticker: CASI), etc. Chinese companies, which have been included in the tentative list of the Foreign Company Accountability Act, will face delisting in 2024, a move that triggered a plunge in all Chinese stocks and mainland and Hong Kong stocks in the United States.

Because the impact is too great, relevant Chinese agencies have agreed to release them. For Chinese companies that do not collect sensitive data, the PCAOB is allowed to conduct on-the-spot audits of Chinese stocks.

Note: PCAOB was originally established as an inspection department in 2002 in response to the Anlong accounting scandal to prevent fraud and misconduct that could result in losses to shareholders.

China-related factors and regulation

Chinese stocks adopt VIE structure

In mid-August 2021, SEC Chairman Gary Gensler asked SEC personnel to stop processing Chinese companies using VIE structures to IPO in the United States. The VIE structure is the structure for most Chinese companies to go public in the United States. Investors should pay special attention. If you invest in a listed company that adopts the VIE structure, you can only distribute the profits of the company, but do not have the ownership of the company’s assets. This is the VIE structure and the biggest difference between listed companies in general.

In the long run, China and the US will decoup

Famous companies are scrambling to separate their operations in China to reduce US SEC oversight and seek independent listings in Hong Kong. The most famous ones include McDonald’s China, Yum China, Domino’s Pizza China, Tucson Autopilot (ticker: TSP), ARM China, etc., all of which have completed the spin-off and listing of their Chinese divisions, or are in the process of spin-off.

Secondary listing in Hong Kong stock market

Almost you have heard of the major Chinese stocks listed on the US stock market, and so far they have completed the secondary listing of the Hong Kong stock market. Statistics in January 2021; in the next three years, at least 40 larger Chinese stocks will return to the Hong Kong stock market for a secondary listing — that is, the US stock market is the main listing place, and the Hong Kong stock market is the secondary listing place. Even when Xpeng Motors (ticker: XPEV) changed to a dual main listed company, Bilibili (ticker: BILI) simply converted Hong Kong stocks into the main market to reduce the risk of being delisted by the United States.

Regulation in China

The actual figures since the Trump era have proved that as long as there is any unpleasantness between China and the United States, which triggers geopolitical issues, all Chinese stocks will fall sharply. What’s more serious is that China’s stocks are now in catch-22 situation, because both China and the United States are suppressing them.

Since Alibaba’s Ant Group IPO was suspended two days before its listing in October 2020, almost all well-known Chinese stocks have fallen by 70% to 50% from their peaks, and the long-term trend has not changed. During the period, Xi Jinping proposed common prosperity, financial technology must be stripped from technology companies and returned to general financial supervision, prohibiting off-campus training institutions from listing, and restricting the public to play online games for only one hour on weekends.

Subsequently, a new regulatory law was promulgated, and companies with millions of users must first undergo a security review and be approved before they can go public. What make it worse is Chinese govenment’s crackdowns and regulatory actions on Chinese tech giants. All of these result in business activities surpressed, unexpected share price big fluctuation, artificial interfere, and infinitely stock diving.

As a result, from the first quarter of 2021, 73 companies planning to IPO voluntarily withdraw their applications, and by the middle of the year, more than 100 IPO applications were withdrawn.

Company nameTickerAll time high price3/31/2022 priceDrop to nowMarket cap ($ billion)

Table 1 shows the decline in the stock price of well-known Chinese stocks since the highest point in the past three years

Chinese stocks are really not worth long-term investment

Three Checks Before Investing in Chinese Concept Stocks

Next time you have an idea to invest in Chines stocks, please check the following points before considering:

(1). Who are the American peers? If you have U.S. peers, please don’t consider Chinese stocks. Usually, investing in US leading peers is much better than investing in Chinese stocks.
(2). What is the long-term return of your current Chinese stocks so far? How is the valuation? What is the growth rate? What’s the outlook? Please take the leader in the US industry as the benchmark standard. How does it compare to the S&P 500 over the same period?
(3). Are you sure that this Chinese stock will still be listed on the US stock market ten years later? Is there any possibility of regulation, delisting, going back to Hong Kong, or going back to China for listing?

The valuation of Chinese stocks is much lower than US peers

The valuation of U.S. stocks to Chinese stocks has always been far lower than that of U.S. peers—this is a “long-term” phenomenon of unfair valuation, not only for Alibaba and Tencent; it is impossible to improve in the foreseeable future.

IndustryCompany tickerStock priceP/SP/EMarket cap ($ billion)Annual revenue ($ million)Annual revenue growth rate (%)Stock performance in past 5 years (%)
Social networkTCEHY46.385.2332.1245586,92919.5752.17
Social networkMETA201.774.8515.31572.14117,92937.1846.69
Search engineBIDU126.733.4828.7544.1612,69813.8-28.84
Search engineGOOGL2553.536.5622.761690257,63741.15197.29

Table 2: Valuation and operation comparison of well-known Chinese stocks and their US peers

Distortion of information

No good news outside of China

Most investors do not read the official financial reports submitted by the listed companies to the SEC, and it is not easy to pay attention to media reports in both Chinese and English. The problem is that since the Trump era, media in both English and Chinese, especially Taiwanese investors, have been reporting on mainland China from a negative perspective under the anti-China and hate-China atmosphere. Almost all of them are negative, and there is almost no positive news or balanced reports; such a situation will cause distortion of information and no facts, and make investors lose the ability to make correct judgments.

Chinese not have an advantage in Chinese stocks

Most of the Chinese are just because the Chinese stocks are Chinese companies, and the Chinese stocks are more exposed in the Chinese media. They believe that Chinese people have language advantages and should understand these Chinese stocks better than Westerners, which are mixed with cultural language, etc. Invest in China stocks from emotional consideration; not because of the long-term performance of individual stocks. Just think: Americans who speak English must understand the US stock market companies better than most people? This is a big taboo in stock market investment without knowing it. Don’t fall in love with stocks. Any prejudice in the stock market will make you pay a serious price.

Chinese stock

Closing words

Finally, I would like to remind you that the biggest risk in investing in Chinese stocks is that “In China, the government has the final say, and there is no way for companies to appeal or protect themselves.” Regulation is one of the important reasons that affect stock prices, and the biggest difference between it and other factors is that government regulation is a factor that companies cannot control by themselves, and has the most lethal force, basically having a coercive force on all companies in the industry.”

I am the author of the original text, the abridged version of this article was originally published in Smart monthly magazine.

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