Are Chinese Tech Stocks Suddenly Attractive Again?

2021 has been a tumultuous year for Chinese tech stocks, to say the least.

Amidst successive crackdowns on outspoken CEOs as well as harsh and targeted regulation of gaming and education sectors, stocks like Tencent (TCEHY), Baidu (BIDU) , (JD) , and more of the country’s tech stalwarts have erased years of gains.

This has been highlighted by the country’s most famous foreign-listed stock in Alibaba (BABA) . With the dovetailing of regulatory issues and an apparently weakening consumer in China, the stock has been among the hardest hit. Accounting for a spending slump in China noted by the company in its Nov. 18 earnings call that sent shares spiraling, the stock has slid about 37% year to date.

“Economic headwinds coupled [with] intensifying market competition also affected our core commerce business in China,” Alibaba CEO Daniel Zhang told analysts in the call on Thursday.

Of course, what he alludes to is a slowing GDP growth in China and an overall slowdown in consumer spending.

While not noted in the call, the crisis in Chinese real estate could well send this from a current slump to a serious crisis in consumer spending. Further, the company’s coffers could be cleared out in coming years by the government in the name of “common prosperity.”

That is not even to mention the monumental political risk that is posed by elevated cross-strait tensions with Taiwan or the ESG concerns associated with investing in a country governed by a repressive autocratic one-party system.

Yet, despite this seeming avalanche of adverse news likely causing many to eschew the market altogether, not all are so bearish. In fact, many top investors are eyeing an appetizing opportunity as the dust settles on regulatory crackdowns.

Attractive Entry Point

It’s an oft repeated phrase, but perhaps repeated so often because it holds some wisdom: “Be greedy when others are fearful.”

The quote attributed to Warren Buffett basically implores investors to keep a cool head and buy stocks when they are “on sale.” In respect to Chinese stocks, this is certainly a tack taken by Buffett’s Berkshire Hathaway (BRK.A) (BRK.B) partner Charlie Munger.

As Alibaba stock slumped to near its nadir, the Munger-led Daily Journal Corp. (DJCO) nearly doubled its stake in Alibaba in the third quarter of this year, moving its stake north of 300,000 shares of ADRs (American Depository Receipts). Prior to Thursday’s slide for the stock, it would have seemed he picked precisely the proper entry point.

As the stock once again reaches the levels it saw when Munger made his move in the third quarter, perhaps another opportunity to buy at a discount presents itself. Further, the opportunity might not be relegated to only Alibaba as many of its large-cap tech peers remain at similarly depressed levels.

“We still see large-cap Chinese technology companies as an opportunity for the next 10 years,” Adam Coons, Portfolio Manager at Winthrop Capital Management told Real Money. “Most of these companies have sound business models, strong free cash flow, and are relatively inexpensive relative to U.S. tech firms.”

He noted that the discount to U.S. firms is a major benefit, as continued growth in China is being discounted as compared to the soaring valuations in U.S. tech.

Proceed With Caution

That said, Coons was not universally bullish and noted that investors approaching the market must be careful to avoid the firms most likely to be targeted by future regulation.

“The companies that will continue to be most vulnerable will be those that have ties to financial markets, such as Alibaba and ANT,” he explained. “China controls its economy through its financial markets and the party will likely maintain a tight grip of control over this segment. We continue to invest into China’s technology stocks through ETF’s, such as [KraneShares CSI China Internet ETF] (KWEB) , and individual stocks such as Tencent, Baidu, and”

Sylvia Jablonski Kampaktsis, co-founder and CIO of Defiance ETFs, seconded the idea that opportunity exists, but only for those shrewd enough to avoid potential pitfalls.

“The companies that pose the greatest growth potential in the fintech, social media, online education, gaming, ecommerce spaces, are taking the biggest hit due to regulations,” she noted. “The Chinese economy remains strong and is a solid country with healthy GDP growth (though slower than expected), solid exports and growth potential.”

As such, she surmised that there is plenty of opportunity, but that it hinges very much on the action of the government in terms of handling these sectors. For Kampaktsis, the main risks are regulatory and political, therefore investors should attempt to target sectors that are somewhat insulated in this regard.

“Chinese stocks are at attractive levels,” she clarified. “However the issue is that the rebound will be very slow, as there is too much discomfort on the table around regulatory concerns, and restrictive measures for these companies.”

In particular, Kampaktsis noted that ecommerce, gaming, online education and fintech are the most vulnerable to further regulation given the existing track record of government crackdowns.

Overall, Chinese stocks are not likely to be on the radar of risk-averse investors. However, given the seemingly unending spate of bad news emanating from the market, a strong case can certainly be made for a contrarian buy-in on some of the nation’s biggest tech names.

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