Is the risk worth the reward?

Chinese stocks fell practically all year. The list of unknowns has grown to such levels that even the most value-conscious growth investor is throwing in the towel at the Chinese market as a whole.

Although Chinese technology stocks look rich in value terms, the perceived risk of investing in the Chinese market has grown exponentially over time. Writing off concerns alone would be too big for any cautious investor to get into such internet giants as Alibaba (New York Stock Exchange: Baba), Tencent Holdings (OTC: TCEHY) or Baidu (Nasdaq: Baidu).

Smaller, higher growth tech stocks (think Pinduoduo)Nasdaq: PDD)) looks more difficult to lag behind, given its inflated volatility and greater risks in the face of a global economic downturn. Also, let’s not forget about the risks of accounting irregularities.

The hard-to-understand risks of investing in Chinese stocks

Although the list of fears is growing, rather than shrinking, by the day, anxious investors may be better off forsaking the high growth market altogether. For those willing and willing to embrace the added regulatory risk of owning Chinese stocks, I think there is a lot of value to be had.

At the end of the day, China is one of the fastest growing markets out there, and the dominance of its big tech companies could rival the big American tech companies we all know and love. In fact, being at the mercy of the Chinese government is never a great feeling. It is difficult to factor in regulatory risks in valuing Chinese stocks.

Regardless, I think a lot of that regulatory risk is being transferred into equity. Any unexpected loosening of regulations could lead to a spike across the board. Of course, speculating when such external events will occur is a fool’s errand. If you have a time horizon (at least 10 years) and are comfortable (preferably with some experience) catching fast-dating knives, actively avoiding Chinese stocks could leave a lot of long-term growth on the table.

How to reduce risks when buying Chinese Internet stocks

I think Chinese internet stocks are worth their average dollar cost (DCA) when they crash. Its growth profiles could have unparalleled potential, particularly once the Chinese economy recovers and companies like Alibaba look to international markets to add to their growth.

Now, the Chinese market already has a world of growth opportunities for a company like Alibaba, as it pursues new market segments. Like the big US tech companies, the big Chinese internet giants are expanding their business into new markets. Payments, video games, e-commerce, hardware, and all kinds of Chinese stocks have, in many ways, growth profiles similar to big tech companies on steroids.

The only piece of poetry in their long-running stories lies in the organizational risk. Chinese companies must comply with the regulations, or else the penalties for skidding for intrusion can be enormous. Last year, Alibaba set an example, imposing a $2.8 billion fine on the chin for its anti-competitive behaviour. Alibaba has committed to change, and other Chinese tech companies are likely to follow suit.

There is no way to truly eliminate regulatory risk. For investors, the best way to go, I think, is with the big tech giants in China. Alibaba and Tencent are two of the top dogs that are down about 78% and 68% from all-time highs.

Fundamentals indicate that both companies are undervalued. However, regulatory risk warrants a significant discount on equity versus fundamentals. It’s hard to know how much regulatory discount shares should charge.

At this juncture, such risks appear to have reached a high point, with Chinese stocks down almost as much as Cathy Wood’s innovation stock. With valuations at rock bottom, Chinese stocks may be worth a contradictory bet for those who understand how much risk they will take.

Chinese stocks minimum

Although there are many interesting options in the Chinese market, I think the average dollar cost of huge ETFs or market-weighted ETFs like the KraneShares CSI China Internet ETF (KWEB) is the best way to go for those who want a bloated pain stomach in a recession.

The stakes with Chinese stocks are high and hard to understand. However, there are also potential rewards.

The ETF option would be best for investors looking for a smoother transition if the de-listing of major US exchanges converts US-traded stocks into Hong Kong stocks.


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