Investing In Chinese Companies? Read This

Chinese stocks are undoubtedly cheap right now. But here are some of my arguments for and against them.

P/S: This is an update to my old post about Alibaba. You can read that story here.
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Also, if you are going to read further, please note that I am merely providing opinions, not instructions or recommendations to buy, sell or hold any form of securities. Please do your own research.

Previously, I was bullish about the future of Alibaba. I am still bullish on its future. But I am doubtful of becoming an investor. However, it is not just Alibaba. It affects most, if not all, foreign-listed (yes, that includes those listed on the Hong Kong Stock Exchange).

Alibaba, when it first went for IPO on the NYSE, it was one of the biggest IPO of the year. The company back then, had a lion share of the online E-commerce market in China. To add more seasoning, China’s middle class alone is the size of the entire US and European population combined and at the same time, their income per household is steadily growing.

However, since late October 2020, the stock has been on a steady decline and has so far lost more than 50% of it’s value from the peak. Do I think its undervalued? Hell, Yeah! But let’s assess the situation a little more:

First, let’s talk about China itself.

Ask anyone today and none will tell you that they can ignore the rise of China. The Chinese are progressing very rapidly whilst many countries are still focused on money, politics, religion and power. Day after day, I see on social media, how advanced the Chinese has become with their technology, how they so successfully contained Covid-19 while the rest of world are still in chaos, how they now even have their own space station and so much more! If you are wondering who your children will have to compete with in the future, watch this video below:

With so much going on with China right now, it makes complete sense to put my money there and take full advantage of it. True! But what I have learnt is that the way I need to invest in China also had to be a little different compared to how I have been doing in the past.

My #1 Investment Policy: I Need To Respect My Efforts.

Any serious full time investor would know, it takes an incredible amount of time and focus to first turn over as many rocks as possible to only discover a potential gem, commit to learning as much as possible about them and following them for years to gain rock solid conviction. Research like this can easily take months. Therefore, to allocate less than 10% of my money to a company I have committed so much on is an insult to that effort. Because let’s say I have allocated only 5% of my capital to that one stock. If I am right and the stock doubles in value, my portfolio would only gain a 5% profit. My aim when it comes to investing hard earned money is NOT to retire comfortably at 65, but to get out of the rat race ASAP. If I cannot convince myself to allocate at least 10% of my portfolio to a stock, I won’t bother even starting a position. In fact, for every company that I want to invest, I will budget at least 15% to 25% of my portfolio.

So now that we have mutual understanding about where I am coming from, let’s go back to China. Why am I not so excited about investing in certain Chinese companies despite its hard-to-deny cheapness? Here are 2 main reasons:

  1. Non-Alignment with China’s Interests

First, imagine yourself being a proud, patriotic US Citizen. Now watch this video:

Imagine now that Facebook is not listed in the US. Instead it is listed in China. Would the senator be making the same joke? In fact, the Americans will be giving Facebook a hard time operating in their country.

Now think about companies like Alibaba, JD.com, Pinduoduo, Tencent, Didi, etc. Where are they listed? When I reflected on this, I understood how sour the Chinese must be feeling all these time. Their industry champions are listed in exchanges that are difficult for their citizens and investors to participate in. Don’t believe me? Here’s the top 10 stockholders of Alibaba:

Now, here’s the top 10 stockholders of Tencent (Listed in Hong Kong):

As you can see, majority in the top 10 shareholders list of these companies are not Chinese investors. They are mostly western institutional investors. You can check the top 10 for many other Chinese companies listed outside of China and you will find similar results. Therefore, I can understand why the Chinese Communist Party (CCP) does not hesitate to give them a hard time.

In fact, I believe that sooner or later, these companies will be called home. China currently has 2 main stock exchanges: The Shanghai Stock Exchange and the Shenzhen Stock Exchange. Soon, they will have the third one, the Beijing Stock Exchange . And I can tell you that the Chinese are wasting no time to set it up as soon as possible because since reading about it 3 weeks ago, when I looked it up again today, it is almost ready to begin trading. See it for yourself here. I am banking to see if I am right about many Chinese companies voluntarily delisting from foreign exchanges to re-list back on the Chinese bourses.

  1. Chinese Communist Party (CCP)’s Word Is The Law

The US began their investigations into their largest tech companies, namely Facebook, Google, Amazon and Apple since June 2020. However, its been 1.5 years and these companies are still operating as if no changes have been made. However, it took less than 1 week for China to halt Ant Financial’s IPO and less than 6 months to make a giant like Alibaba change their business practices and kneel to the might of the CCP. Notice the big difference here. This is because unlike China, the west are used to fighting back through the courts and have every financial capability to hire the best lawyers and contest previous court decisions. This is why it is very hard for the west to enact necessary changes. You don’t see Alibaba dragging the CCP to courts about their decision. All it took was the CCP agents to conduct an investigation and the next moves were big changes and big fines.

And we can see this across many (and I mean many) different Chinese tech companies. We have seen founders and CEOs of several Chinese tech companies like JD.com’s Richard Liu, TikTok’s Zhang Yiming, Pinduoduo’s Colin Huang and most recently, reports of Didi’s Jean Liu stepping down from their leadership positions within the company. Apparently there was a disturbing comment she made to her associates that she expected the government to eventually take control of Didi and appoint new management. So far the company denied the claims, but I will not be surprised if it eventually happened. And has anyone heard from Jack Ma lately? Imagine you invested in Amazon because of the ruthlessness of Jeff Bezos but suddenly the US government decided to overthrow him and appointed someone else to run the empire. Would your confidence in the company remain the same?

Another trend I have been seeing is that these Chinese companies have been donating their profits to help develop different parts of the country and its economy. They did this to make sure that they are aligned with the CCP’s policy of common prosperity. In fact, Tencent has donated up to $15 billion to avoid any potential headwinds from the government. While these national services will help China greatly especially in reducing prosperity gaps, it comes at the expense of shareholders! Those profits can be used for growth developments, strengthening their economic moat or at least to pay dividends.

And that is not the scariest part. The scariest part for me is that they can easily within a very short period of time implement changes which can fundamentally alter a company’s business model. Look at Gaotu TechEdu. 94% of their revenues affected just because the CCP decided to ban profiteering from compulsory education. Within a short period of time after that announcement, the stock lost more than 90% of its value. As an investor, I would have probably lost almost everything before I can even evaluate the situation.

The latest case is China’s Evergrande Group

Although the company had a lot of debt on their books, they were happily chugging along, taking down payments from property buyers and re-financing their debts to continue their growth. It was perfectly balanced (although probably too aggressive for me to grow like that with debt) and everyone was happy. That was until the CCP started limiting how much debt it could take. That particular policy tipped the scales and sent Evergrande into a downward spiral ever since. I am not saying that the policies are bad. What I am trying to point out with these few examples is how easy is it for the Chinese government to enact changes that can fundamentally alter your company’s business model. With a snap of a finger, Alibaba even had to divest the popular South China Morning Posts.

To Put All Together…

With all these observations, how can you expect me to comply with my policy to respect my efforts?

How will I dare to put a huge chunk of my hard earned money into the stock when I know all it took was President Xi to make a public comment and I will see my stock price plunging overnight with no clear signs of recovery? As mentioned, if I cannot convince myself to invest at least 10% of my portfolio, then its not even worth a 1% stake in the portfolio. Hence, these are some of the reasons why I stayed away from foreign-listed Chinese companies.

But What About The Chinese Growth Story?

Personally, I will find a better way to participate in China’s growth. Especially one whereby the Chinese will have as little reasons as possible to shoot their own foot. The best way as of now is to invest in Chinese companies listed directly in the Chinese stock exchanges, namely the Shanghai and Shenzhen stock exchange. Stocks listed there tend to be majority owned by Chinese institutions or retail investors. The CCP will therefore be less motivated to harm their own people.

Remember the donation made by large Chinese tech companies? Look at their giant distiller, Kweichow Moutai. They made donations to the government but got sued by shareholders for it.

Not only are they listed directly in China, but a quick glance at their top 10 shareholders can also somewhat explain their courage to sue the company. Majority are Chinese investors or institutions.

Another consideration you can make is to buy ETFs that invests in Chinese companies listed in China itself. Some worth mentioning are KraneShares SSE STAR Market 50 Index ETF (KSTR), Ishares Msci China A Etf (CNYA) and KraneShares Bosera MSCI China A Share ETF (KBA). My favourite is KSTR.

In Summary or TLDR

Do I think Chinese technology companies are very cheap now? Yes. They are dirt cheap.

Do I believe there can be a big upside? Yes. If it recovers, the upside will be huge.

Will I invest in them? No. Despite the big upside, I cannot convince myself to invest a meaningful portion of my portfolio to respect my commitment to research and follow the companies.

Am I foregoing a big opportunity? Yes and No. The upside if these Chinese stock recovers is huge. But if I am only convicted to put less than 10% of my money in, then the upside will not be meaningful enough for me. Besides, there are plenty of other opportunities with a big upside that I dare to put a large portion of my money in. Those will give me a bigger upside in terms of total portfolio value.

Should you take any advice from me? Definitely NOT. I am just sharing my thoughts and opinions. You do your own due diligence.

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