What’s happened
Concerns about investing in Chinese tech stocks came to a head on Monday when international megabank JP Morgan announced a “double downgrade” of three of China’s biggest tech companies: Baidu (BIDU -8.37%), NetEase (NTES -9.56%) and Alibaba Group Holding Limited (BABA -10.32%).
As of noon ET, NetEase shares are down 7.2% from Friday’s close, Baidu shares are down 7.5%, and Alibaba leads China’s tech sector with an 8.2% loss.
Image Source: Getty Images.
So what
What is wrong with Chinese technology today? First, there is an ongoing risk that many Chinese stocks, even the largest ones, could be delisted from US stock exchanges if the Chinese government cannot find a way to work with its US counterparts to allow full and accurate audits of Chinese companies’ financial statements. .
It was the biggest downside for Chinese equities last week. But as JP Morgan explains in its note on Alibaba’s downgrade, Chinese tech stocks have problems specific to China, in addition to the risk of being delisted in the US. Currently, according to the analyst, “risk management [has become] the most important consideration for global investors in relation to their online investment strategy in China.” And in this light, “Chinese Internet [stocks look] unattractive in a 6-12 month perspective with unpredictable stock price outlook, depending on market perception of China’s geopolitical risks, macroeconomic recovery and Internet regulation risk,” JP Morgan notes in a note published by StreetInsider.com.
Consequently, shares of Baidu, NetEase and Alibaba are suffering “negative inflows” as international investors dump shares, TheFly.com notes. And the fact that JP Morgan is now pricing every stock as undervalued (i.e. selling) doesn’t matter much.
What now
Of course, there will come a point when this sell-off ends, and when it does, JP Morgan believes investors can look forward to “potential multi-packs” among Chinese tech stocks. However, investors should be concerned about what price these shares will start at once they reach multipack status.
Obviously, the cheaper a stock is at the start, the easier it will be for them to double, triple, or more. And that makes the valuation of Chinese stocks of paramount importance. But NetEase is currently the cheapest of the three technology names above, with a 25x profit. Alibaba comes next with a 28x profit estimate, followed by Baidu with a 36x profit estimate.
Simply put, even though these stocks are not overly expensive, none of these stocks actually look “cheap” based on current P/E ratios. JP Morgan warns that in the absence of clear and compelling “valuation support,” “the sell-off across the sector could continue.”
This article represents the opinion of the author, who may disagree with the “official” recommender position of premium consulting service Motley Fool. We are colorful! Questioning an investment thesis — even one’s own — helps us all be critical about investing and make decisions that help us become smarter, happier, and richer.