Is It Time To Buy Chinese Stocks?
Chinese stocks have been beaten dow for a long time but it’s possible that a tectonic shift is taking place. It’s been such a puzzle to understand why their valuations have been low for such an extended time period that even the likes of Charlie Munger got fooled by cheap valuations.
One overarching challenge has been the ongoing regulatory environment. Specifically, a big furore around Jack Ma disappearing for seemingly months on end while his company Alibaba was innovating with a new financial arm.
The valuation is still seeming low at $183 billion despite the company generating $130 billion in revenues and $14 billion in net income.
So, what gives, is there a sign that the tide may be turning?
Key Points
- Chinese stocks have been beaten down for many years but a key technical breakout has just occurred.
- Of all the Chinese stocks, Alibaba appears to be among the most attractive from a valuation standpiont.
- A discounted cash flow forecast and analysts consensus both imply substantial upside from present levels.
FXI Breaking Out
Chinese ETF, FXI, has been on a multi-year downtrend relative to the S&P 500 but the tide may be finally be turning. In the chart below, you can see that the FXI has broken above the downtrending resistance line relative to the S&P 500 that has held for so long.
That breakout may well signal that Chinese stocks are set to rebound relative to US stocks over the coming months, and perhaps even years. If so, which ones come top of the list of prime candidates?
Jack Ma’s Alibaba continues to stand out as an attractive valuation play. With a market cap of $183 billion and generating $130 billion in revenues, Alibaba is a giant on the top line but modest on the valuation front.
It’s even more perplexing when looking at the net income of $14 billion and P/E ratio of just 13x. That’s a good bit under what is believed to be Buffett’s line in the sand of a 15x P/E.
So what is it that Charlie Munger found distressing enough to sell if the valuation looks so good? He claimed that amid all the hype of China and internet stocks, Alibaba remains nothing more than an e-commerce retailer.
47% Upside In Alibaba?
Nonetheless, at some stage valuation becomes so compelling it’s hard to ignore and it appears that might be precisely where we’re at. Much in the same vein as Buffett used to invest in what he called cigar butt stocks, those that were trading at a discount to fair value, even if they weren’t going to light up the world, Alibaba might well be one of those opportunities to buy a stock that is seriously undervalued.
When a discounted cash flow forecast is run, Alibaba appears to have 47.5% upside to fair value of $111 per share. That’s a little above where analysts have pegged fair value at $104 per share but the two figures at both within close proximity and likely does reflect where BABA share price should be.
Sitting so far south of those levels in the mid-$70s appears to offer a highly attractive long-term investment opportunity.
