China Securities has ushered in a rare opportunity for reverse investment. Monetization, etc. are the key to avoiding the “value trap”

Red Weekly Special Agent | Chen Da

Due to their special geographical relationship, the Chinese securities market is like a pressure relief ball. In the context of the game between China and the US, whoever needs to work hard will take a few steps.

Over the past year, there has been a sharp correction in China Securities. In particular, Chinese securities listed in the US. Compared to the S&P 500 Index, which has repeatedly reached new highs, the S&P US China Securities 50 Index fell by more than 40%. However, in reality, the reduction in the valuation of China Securities is not only due to policy adjustments, but also because the number of Chinese shareholders is close to its peak, and customer acquisition costs remain high, making Chinese Internet companies more and more like “utility” companies, and the valuation level cannot go back to 10 years ago. However, as far as the present is concerned, the author believes that China Internet has opportunities for reverse investment, but “digging the bottom” is skilled; otherwise, it will fall into a “value trap.”

There are many factors that kill valuation

Stalling growth is the biggest crime

In terms of valuation, the MSCI China Index, which fell 21.64% in 2021 (mainly including large Chinese companies listed on US and Hong Kong stocks), the price-earnings ratio in the last 12 months was only 6.2 times, which is an absolute low in history. The dynamic price-earnings ratio of the Hang Seng Technology Index is 31 times, and it is also in a historically low range since the index was established.

The main reasons for the decline in stock estimates and weak valuations over the past year are as follows.

First, the current inflation problem in the US is getting worse. Based on annual growth, the US CPI gradually rose from 2.6% in March 2021 to 7% in December 2021, the highest value since 1982. Originally, the Federal Reserve viewed US inflation as a “temporary problem,” but now it may have to treat it with the attitude of a protracted war. Federal Reserve Chairman Powell publicly stated that interest rates will continue to be raised if necessary. This will support the US dollar and cause the dollar to flow back to the US. Liquidity recovery is generally not beneficial to emerging markets. Under expected management, emerging market stock markets will be under pressure.

Second, it is due to the plight of China Securities itself. For some reason, China Securities's business is relatively difficult to go overseas, so the ceiling of its users is also obvious. The number of Chinese netizens has basically reached its peak. Currently, traffic and marginal customer acquisition costs are rising rapidly, and growth is becoming more and more difficult. The so-called growth stalled is the biggest crime of growth stocks. Once an increase covered everything, many problems will be magnified by the capital market, and then a round of evaluation will begin.

Overall, it all boils down to four words: the same origin of profit and loss.

This is a market-side reason. It is a natural industry cycle. Every industry faces this kind of cyclical evolution, and various Internet companies are also continuously protecting their growth rate through investment and other methods. However, China Securities is facing a non-cyclical negative factor in the industry, namely the regulatory attitude of the two countries towards “barbaric” growth and repeated breakers of the rules.

On the US side, the regulatory requirements for China Securities to continue to be listed and traded in the US have always been like a sword of Damocles hanging high above the head. In December 2021, the US Securities Regulatory Commission passed the amended rules of the Foreign Company Accountability Act. It was confirmed that starting in 2022, if PCAOB is unable to review the issuer's accountant for three consecutive years, the stock will be banned from trading on US exchanges and forced to be delisted from the US stock market.

In contrast to US regulation, according to the relevant provisions of China's securities law, overseas regulators, including PCAOB, are not authorized to conduct investigation and evidence collection activities within China; listed companies and auditors are also prohibited from providing documents and data relating to securities business activities abroad without approval from the competent authorities.

Due to the difficulties involved in disclosing sensitive information, this has undoubtedly added a lot of anxiety to Chinese companies listed in the US and their investors. This difficult settlement has prompted more and more Chinese securities companies to return to the Hong Kong stock market and go public for a second time.

However, it should be noted that according to the regulations of the Hong Kong Stock Exchange, after comprehensively considering factors such as the current market value, revenue, net profit, and corporate structure of listed companies, the author found that in the US stock market, probably less than half of the companies in the US stock market met the “second marriage” requirement and were successfully listed in Hong Kong.

Under the pressure of various regulatory policies, many foreign-funded institutions are reluctant to take the attitude of Chinese securities, even if they are liquidated. For example, Ark Invest, which is headed by Cathie Wood, known as the American female Buffett, changed its investment in Chinese securities to a rapid complete withdrawal from many Chinese securities. For example, ARK's flagship ETF, ARK Innovation ETF (ARKK), has cleared all Chinese securities, including Baidu and Tencent stocks, which once had quite a few positions.

Don't blindly “copy the bottom”

Three key points to help avoid the “value trap”

When will the fog dissipate, and where is the way out for China Securities? The author's attitude is not as pessimistic as the market. In fact, there are long-term prospects and short-term opportunities.

Specifically, many people regard China Securities as “victims” of the game between the two countries, yet they ignore that a barbaric capital force in the development of the Internet is driving the industry to expand in a disorderly manner. It is only responsible for efficiency, and there are no supporting institutional restrictions. In fact, whether in China or the US, the regulation of the Internet and related data and privacy issues is the same.

Positive changes are taking place. Recently, with the gradual implementation of policy supervision, the competitive order of the Internet industry is becoming standardized, and the marginal impact of policy risk is gradually weakening. We see that after recently reducing its SEA holdings, Tencent has begun some normal industrial chain investment and mergers and acquisitions. In a more orderly developing market, Internet leaders with high barriers have obvious advantages in all aspects. Whether it is upstream and downstream mergers and acquisitions in the industrial chain or the layout of hard technology, their prospects are relatively advantageous.

The author believes that at present, China Securities is a rare opportunity for reverse investment. We can enter the market when the valuation is low, and then wait patiently for the performance and valuation Davis to double. Of course, we can't blindly do so-called “bottom copying,” because we don't know if we'll fall into a value trap.

Specifically, focusing on three key points can help avoid value traps. First, choose companies with performance, physical assets, positive cash flow, and strong user stickiness. This itself is also meant to adapt to an environment of downsizing and interest rate hikes that the US is likely to face. In an environment of interest rate hikes, higher discount rates for future cash flows are often bad for pure growth companies whose main value is based on imagining the future.

Second, due to the slowdown in user growth and the sharp rise in customer acquisition costs, we need to choose Internet companies that do a good job in monetization and can monetize, rather than simply pursue the high growth rate of users. When investing, switch from a MAU/DAU growth rate model to a high ARPU growth rate model. This not only sees profit returns, but also avoids the impending risk of a ceiling.

Third, try to select companies that have already gone public in two or even more places to reduce the policy risks of the listed places.

Based on these three conditions, the stock pool we selected should be a stock pool dominated by Internet leaders. It is a stock pool combining valuation and growth, with high competitive barriers and high certainty. Alternatively, you can also invest or invest in the China Futures Index. Essentially, you are also reaping a basket of leading Internet stocks.

(The author is an executive director of Hwa Hop Wealth (Hong Kong)). (This article was published in “Red Weekly” on January 15. The opinions in the article only represent the author's personal opinion and do not represent the position of “Red Weekly”. The mention of individual stocks is only an example analysis, and no trading suggestions are made.)

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