1.4 Billion Reasons to Buy These 3 Tech Growth Stocks

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In a twist of irony, the biggest economic success story in the last 50 years did not occur in a capitalist country, but rather in China. 

From 2010 to 2020, China has seen its GDP grow 141% versus the United States’ growth of 17% during the same period. 

It is expected that China (and its massive population of 1.4 billion people) will eventually overtake the United States as the world’s largest economy, with the UK-based Centre for Economics and Business Research predicting this will occur by as soon as 2028. 

Against this economic backdrop, you’d naturally expect Chinese stocks to have been a bonanza and, at minimum, beaten the pants off their American counterparts… and you’d be mostly wrong. 

In fact, a $10,000 investment in the Shanghai Composite would be worth $15,400 today, good for an annual return of 4.4%. The same investment in the S&P 500 is now worth $37,300, or returns of 14.1% per annum. 

Here are 1.4 billion reasons to buy these three tech growth stocks out of China.

Alibaba is too cheap to ignore

  • Alibaba Group Holding Ltd. (NYSE:BABA)
  • Price: $87.69 (as of close May 19, 2022)
  • Market Cap: $235.667B

The “Amazon of China” has recently seen its fortunes diverge from its American counterpart, with shares down 45% over the last one-year period. 

The biggest difference has been a change in regulatory regime, starting with the fallout from founder Jack Ma’s criticism, as noted above. Tech companies have recently been confronted by regulators due to anticompetitive behavior on their platforms, including the record $2.8 billion fine for Alibaba (NYSE: BABA). 

Fines attract headlines, but it appears the fixes are less impactful than many initially feared. Recently, Alibaba and Tencent were ordered to stop blocking links to each other’s websites on their platforms in an effort to encourage competition.  

It’s true Alibaba’s growth rate is slowing but not on account of government intervention. Smaller rivals like JD.com and Pinduoduo along with tech conglomerate Tencent are picking up share in its core ecommerce division and the latter in cloud computing. Still, the company reported year-on-year growth of 34% (22% excluding recent supermarket Sun Art acquisition). 

Yet all these risks appear baked in at this point. Currently shares of Alibaba trade at 4 times sales and 20 times forward earnings. As a point of comparison, Amazon trades at 4 times and 46 times respectively. Unlike Amazon, however, Alibaba is a domestic market that in the long-term will grow at multiples of the United States with a population nearly three times larger. 

Investors are increasingly looking at Alibaba’s strength outside of ecommerce. Like Amazon, Alibaba has a cloud computing division and that is well situated to be the next profit center for the company. In the last quarter, Alibaba Cloud swung from a loss last year to a profit on the back of 29% revenue growth. According to data from Canalys, Alibaba Cloud is the largest provider in the country as of the second quarter with a 34% market share.  

Alibaba might not hold market dominance in both ecommerce and cloud like it once did, but China will not be a winner-take-all market and Alibaba’s stock appears undervalued based on their current market conditions.

But don’t think the company is resting on its laurels. Alibaba recently acquired Sun Art to move deeper into brick-and-mortar retail and to improve upon its distributional network. Additionally, it recently announced it will develop its own silicon chips to improve its cloud offering. These two actions will make it more difficult for upstarts to grow share as we move forward.  

Alibaba might be shunned among Wall Street, but it has a high-profile acolyte in the form of Charlie Munger. The Berkshire Hathaway vice chairman doubled down on the stock by adding 165,000 shares in the third quarter through his portfolio at The Daily Journal.

Tencent is an all-of-the-above Chinese tech juggernaut

  • Tencent Holdings (OTC:TCEHY)
  • Price: $44.87 (as of close May 19, 2022)
  • Market Cap: $415.114B

Warren Buffett is an investing legend, but his philosophy is rather simple: buy high-quality companies when they’re on sale. When it comes to best-of-breed Chinese Internet companies, Tencent (OTC: TCEHY) immediately comes to mind. 

In fact, The Motley Fool author Jeremy Bowman once compared Tencent to Berkshire Hathaway due to its massive $250 billion investment portfolio. Unlike Berkshire, however, Tencent’s portfolio is chock full of positions in next-gen technology startups and other large Chinese companies like JD.com and EV-maker Nio

The Chinese Internet conglomerate has major businesses in video gaming through Riot Games and Epic Games stakes and music under its Tencent Music umbrella. However, the company is most known for WeChat. In fact, outside of the Facebook family of apps, WeChat is the largest social media platform, boasting nearly 1.25 billion monthly active users. 

Tencent shares have been under pressure for the last year, down 12%, as China’s tech crackdown has made investors skittish. Despite the bearish narrative, Tencent continues to outperform expectations in a difficult environment. 

In the second quarter, Tencent met analyst expectations for 20% revenue growth and beat bottom line consensus by posting a 29% increase in profit. Mobile games sales were up against tough comparisons as last year’s pandemic lockdown period boosted adoption, but Tencent still reported 11% growth in this segment. 

However, the company’s FinTech and Business Services segments jumped 40% year-over-year as decreased demand for digital payments and its cloud services led the way. While Tencent Cloud trails Alibaba, the company is stealing share growing from 15.1% in the second quarter of 2020 to 18.8% in 2021 per data analytics firm Canalys. 

Tencent has always held a reputation of being judicious in monetizing its assets, so the company has many growth levers to pull while trading at a cheap valuation of only 25 times forward earnings. 

China’s growth might be slowing in the short run, but the long-term demographic trends remain intact. Earlier this year the country reported having nearly 1 billion internet users, up 85 million during the year. Look for these new netizens to begin shopping, livestreaming, and communicating through social media channels, which will boost Tencent’s bottom line for years to come. 

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Bilibili is an under-the-radar Chinese tech growth juggernaut

  • Bilibili (NASDAQ:BILI)
  • Price: $21.59 (as of close May 19, 2022)
  • Market Cap: $8.433B

Apparently, Bilibili (NASDAQ: BILI) didn’t get the memo that Chinese regulators were cracking down on technology stocks. Shares of the anime, comics, and gaming-focused video-sharing site appear to be unaffected, up nearly 70% in the last year, despite new regulations that limit the time minors can spend playing video games. 

Bilibili is likely overlooked in President Xi’s war against big tech on account of its relatively small market capitalization. At a $30 billion valuation, the company is only a fraction of Tencent ($600 billion) and Alibaba’s ($470 billion) size, which protects it against accusations that it’s an anticompetitive monopoly.  

However, Bilibili is by no means a small platform. The company boasts nearly 240 million monthly active users, a population larger than Pakistan, the fifth largest country! Not only is Bilibili a large network, but most users are 35 years of age or younger, a demographic highly desired by advertisers. For years Bilibili held off on aggressive monetization to grow its user base and add to its network effects. 

While the company continues to care about the user experience, Bilibili is beginning to take steps to prioritize monetization. In the most recent quarter, Bilibili reported a 72% top-line increase from the year-ago quarter. The company is firing on all cylinders, as monthly paying users (aka subscribers) rose by 62% while advertising revenue grew 200% during the period. 

Like all stocks, Bilibili has risks. It is a true growth stock, as evidenced by the fact that the company is richly valued at 12 times sales and is still unprofitable. However, the company’s rapid growth and narrowing losses point to future profits ahead. Regardless of China’s economic backdrop, Bilibili has a long runway for growth as it continues increasingly paying subs and bringing more advertising to its platform.

Why aren’t investors all-in on China?

The stock market can be complicated, but at a base level, stock returns are a function of two drivers. The first is prior earnings, assets, and cash flow. The second is what’s referred to as multiples, or the valuation premium investors are willing to pay for future performance. 

It’s possible for a company (or even a country) to experience robust growth and for stock prices to decline or stagnate as multiples contract. That’s what’s been happening in China during the last decade, and despite broad economic growth, investors have become skittish about the outlook. 

The Communist Party of China’s name might conjure images of aggressive command and control a la the U.S.S.R., but the truth is more nuanced; the country has been more liberal in its treatment of foreign and domestic investments.   

In fact, China opened the Shanghai Stock Exchange (SSE) in 1990 to raise money for its state-owned enterprises and the country continued to move toward capitalism, allowing private companies to raise money, particularly in the technology sector. As of today, the SSE is the third-largest stock exchange in the world behind the United States’ NYSE and Nasdaq. 

Additionally, China has historically been supportive of listing its domestic companies on American exchanges. In fact, the unofficial arrival of the Chinese on the economic world stage was Alibaba’s (NYSE: BABA) massive $25 billion IPO—the highest ever at the time!

However, investors are reacting to a pendulum that is swinging back in the other direction. In recent years, China’s liberalization has slowly been clawed back in ways that have given investors pause. These concerns have intensified in the last year amid a few high-profile events:

  • After criticizing financial regulators, Alibaba founder Jack Ma Yun disappeared from the public eye for months and his next venture, Ant Group, had its IPO shelved. 
  • Alibaba was hit with a record $2.8 billion antitrust fine by Chinese regulators, the start of a series of fines that have affected at least 12 tech companies. 
  • After DiDi Global (NYSE: DIDI) went public in the United States without the formal blessing from Beijing, it was forced to pull its app from Chinese app stores. 
  • Recent criticisms from President Xi Jinping concerning “excessive income” have prodded China’s rich to do more with their companies to boost society. 

China’s strongest argument appears to be weakening

China’s rhetoric has historically been ignored by investors on account of the strong economic growth. As an example, in 2020 the country’s GDP per person was $10,500, which was 10 times more than the $959 it was in 2000 (for comparison, our GDP/capita during that period grew about 1% per year)! 

The argument was that regardless of the whims of China’s government, economic growth made China equities too important to ignore. However, recent events have given investors reason to question this thesis. In 2019, full-year GDP fell to a 30-year low and the recession cut that figure in half. 

China’s economic growth was led by a robust property market, particularly residential construction. With the explicit approval of China’s government, property developers often built entire cities on speculation. The “build-it-and-they-will come” model often didn’t work out—many of these citizens never moved and the buildings remained vacant. 

These so-called “ghost towns” initially boosted GDP but are now becoming a symbol of wasted money and a drag on future growth. In fact, China’s third-quarter growth slowed to 4.9%, missing expectations of 5.2% and significantly lower than the country’s 6%-plus pre-pandemic growth rate. 

Developers like China’s Evergrande took out $300 billion in debt to build these ghost towns and are now on the hook to pay back investors. The debt overhang conjures images of the Great Financial Crisis in America and has the potential to hurt the entire country. 

Is recent underperformance an opportunity?

China’s recent growth issues and property concerns might be a blessing in disguise for investors. It’s unlikely the Chinese government will allow its property market to become a “Lehman-level event” like the one that destroyed the global economy in 2008. 

At the same time, China wants to move beyond its reputation as the world’s assembly factory. President Xi has ambitious plans for China’s technology companies to compete and lead on the world stage per his “Made in China 2025” diktat. 

When the overall economy is strong, it’s easier to decry large companies and prod for changes but it’s harder to do so when growth is slowing in other areas of the economy. The result? It appears the recent sell-off in Chinese stocks might be overdone and an opportunity for long-term investors. 

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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool recommends Bilibili. Millennial Money is part of The Motley Fool network. Millennial Money has a disclosure policy.

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