Chinese technology stocks are on sale

 

For those who follow the market closely, it will come as no revelation to hear that Chinese Internet stocks have generally under-performed this year, but things got precipitously worse last week when Chinese online gaming giant TenCent reported it second quarter results, falling more than ten cents short of analyst’s expectations. In fact, TenCent’s quarterly year-over-year profit fell for the first time in 13 years.

So why is that important? Because playing games is the first thing Chinese people do when they go online, so now it seems as though the number of people online in China has peaked, at least in terms of their spending trends. Many have concluded that if the Chinese are spending less online, the trend could have a detrimental effect on many other companies, beginning, of course, with e-commerce sites. The argument is not only convoluted, it’s wrong: if the Chinese aren’t playing massively multiplayer online games, they are surely doing plenty of other things online. I, for one, intend to ride the Chinese internet dragon a bit further yet.

Remember to treat these ideas as just that, ideas, and do your own research before making any investment decision.

Baidu (BIDU)

In China, the internet is heavily censored, and while savvy tech guys can sometimes find ways around that, the government fights hard to quell any outbreak of unsanctioned information. Because this means that Google, at least as we know it, does not exist in China. There are numerous beneficiaries, but the biggest is Baidu. Baidu is more than just a search engine, though, as much like Google, they have parlayed the enormous traffic on their site into a little empire of online functions, some of which customers pay for, and a great many of which support ads. Baidu’s revenue grew 30% in 2017, and analysts are calling for a 14% gain in 2018 and a 22% gain in 2019. Analysts expect earnings to rise extremely rapidly as well, from $7.76 in 2017 to $10.23 in 2018 and $12.32 in 2019. Why does a company with such rapid growth have a trailing P/E that is considerably lower than the average for all S&P 500 stocks? There are a lot of seriously freaky values in Chinese tech stocks right now, and this isn’t even the freakiest.

Chart courtesy of www.stockcharts.com

58.com (WUBA)

58.com is a Chinese online classified ad company. It is the largest online recruitment platform in China, but it continues to roll out new services as well, including a real estate platform, an online wallet, and C2C used goods sales. There is competition in all these areas, to be sure, but 58.com seems to have some real appeal, as users continue to flock to the service. WUBA stock was faring much the same as other Chinese tech companies until August 15, when it reported its second quarter results. Revenue came in at $519 million, up 32% from the year-earlier quarter and 9% higher than the consensus estimate. Earnings were up 21% year-over-year and 17% higher than the consensus estimate. You can play WUBA for its individual momentum even as you play the sector for being oversold.

Chart courtesy of www.stockcharts.com

YY (YY)

YY will always have a place in my heart, as I put a lot of effort into figuring out what the company actually is and what it actually does. The company allows people to meet in video chat rooms. In some cases, one person performs for a group, but in others, it’s more like a one-on-one date. There is music, karaoke, lots of video games… It doesn’t directly translate into anything that we have in the US, but if you’ve ever been on Chinese streets, you won’t find it odd that many Chinese choose to avoid the pollution and traffic and meet-up in cyberspace while remaining in their own homes. Earlier this year, I switched my support from YY to one of its competitors, MOMO, largely because MOMO was doing a better job getting people to use their service on mobile phones. Now I’m back to YY due to its low price. In January, YY shares hit $140, but since then, the company’s financials have been mixed. In the second quarter, YY beat the Street’s earnings forecast, but missed slightly on revenue. There is also concern about competition, of course, but it’s hard to figure out why that would make the stock lose almost half its value, falling to $76.

Chart courtesy of www.stockcharts.com

SINA (SINA)

When the brilliant young entrepreneurs / powerful government officials who started Baidu realized they could simply wish Google into a cornfield, they must have thought they were on easy street, but they could not stop other Chinese companies from jumping up and claiming their own slice of China’s internet pie. Among these, was the company that today is Baidu’s biggest competitor, SINA. I may be saying this a lot today, but this company’s growth is amazing. In its past four quarterly reports the company has reported a year-over-year earnings growth rates of 61%, 61%, 59% and 50%. It has a reasonable sounding trailing P/E of 34—reasonable, that is, until you compare it to the growth rate using a handy measure called the PEG ratio. SINA has a PEG of just 0.66, where anything less than 1 is generally considered a value.

Chart courtesy of www.stockcharts.com

JD.com (JD)

JD is the only stock on today’s list in which I own shares. It is also, obviously, my favorite of the stocks on today’s list, and here’s why. JD is a Chinese internet commerce giant, a pioneer in fulfillment that is spreading the power and equality of a central marketplace into the farthest flung and most remote regions of China. JD stock has been a flop this year, falling in sync with other Chinese internet stocks, and missing its expected revenue numbers twice in a row. That sounds like a good reason for a stock to fall 25%, and it would be, if the stock were not astonishingly undervalued to begin with. JD is expected to cross into profitability in 2018, and, of course, when a company with great potential reports its first positive EPS, that almost always gives the stock an extremely high — though anomalous and meaningless — P/E ratio. In this case, JD forecasted 2018 earnings would result in a trailing P/E ratio of 5.5. That’s right, 5.5, despite the fact that many companies growing at this rate have a trailing P/E ten times higher and are still counted as bargains. Since those of you with real lives may not be lighting fast at unpacking the various ramifications of the P/E ratio, I’ll explain. If JD.com merely hits consensus performance forecasts, JD shares could be ten times higher a year from now and still be a good buy. Look at projected 2019 earnings and the projected trailing P/E falls to 3.3. Now that’s what I call anomalous.

Disclosure: I own shares of JD.com (JD).

Chart courtesy of www.stockcharts.com

Symbols: BIDU JD SINA WUBA YY
Julian Close

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

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