Chinese stocks are an interesting group, in the sense that both the bull and bear cases are fairly self-evident right now.
The bull case is relatively simple. China is the world’s most populous nation, just ahead of India. With nearly 1.4 billion citizens, its population is more than quadruple that of the U.S. In fact, it’s larger than the U.S., Canada and Europe combined.
Of course, per capita income is far lower than in developed nations. But China’s economy continues to grow annually at a 7%-plus clip. One expert believes the country’s gross domestic product will surpass that of the U.S. in roughly a decade.
Thanks to that growth, tens of millions of Chinese consumers enter the middle class every year. And so any company that serves the Chinese market, let alone leads it, should have years of revenue and profit increases ahead simply from improvements in underlying demand.
But the bear case too, makes a lot of sense. China remains a single-party Communist state. Capital controls impact shareholder returns and corporate structures. Governance standards are far more lax. And more than a few Chinese companies have executed significant frauds.
There’s truth to both sides of the argument. Investors should consider Chinese stocks for their portfolio. They should also be careful in which Chinese stocks they pick.
Here are eight Chinese stocks to avoid right now:
- Pinduoduo (NASDAQ:PDD)
- PetroChina (NYSE:PTR)
- XPeng (NYSE:XPEV)
- iQiyi (NASDAQ:IQ)
- Luckin Coffee (OTCMKTS:LKNCY)
- Mogu (NYSE:MOGU)
- Kandi Technologies (NASDAQ:KNDI)
- GSX Techedu (NYSE:GSX)
In some cases, the issue is valuation. For others, governance raises red flags, while a few simply aren’t performing all that well. Even for investors willing to take on the broader risks of Chinese stocks, these eight stocks look like they should be avoided.
8 Chinese Stocks to Avoid: Pinduoduo (PDD)
There’s actually a strong case in favor of PDD stock. What Pinduoduo has accomplished up to this point is extraordinary.
This is a company that was just founded in September 2015. Five years later and it has generated $5.4 billion in revenue over the last twelve months. By focusing on smaller cities, it’s quickly taken significant market share from Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) — both fearsome competitors in their own right.
But there are concerns as well. Valuation is a question mark, even with PDD stock pulling back over 20% in recent weeks. The stock still trades at about 17x sales — an enormous multiple for an online retailer. Profits are expected next year, but at 47 cents per share, remain minimal.
Meanwhile, Pinduoduo’s founder, Colin Huang, surprisingly stepped down in July. The resignation has sparked questions about the timing, and adds to general weakness at the top of the company. Pinduoduo has never had a chief financial officer, and still has no chief operating officer or chief technology officer.
In fact, its own management page names just three executives. And this is a company with a $91 billion market capitalization — higher than Anheuser-Busch InBev (NYSE:BUD). For a stock where execution is paramount for the bull case, the lack of C-level talent compounds valuation concerns.
PetroChina stock has a different set of issues. Valuation, at least on its face, is far less of a concern: PTR trades at just 20x consensus earnings per share estimates for next year.
Governance, too, seems acceptable, particularly by the standards of Chinese stocks. PetroChina has been listed on the New York Stock Exchange since 2007. (For a brief moment after its initial public offering, the company was worth over $1 trillion).
Rather, there’s a core question with PTR stock: should investors own this particular integrated oil and gas play? After all, there is no shortage of options among American and European names. Exxon Mobil (NYSE:XOM), BP (NYSE:BP) and Chevron (NYSE:CVX) are among the choices for sector bulls.
PetroChina stock does offer an 8.5% yield, which might entice income investors. But high yields aren’t necessarily a buying signal, and XOM now yields a whopping 9.9%. Investors willing to bet on energy or on high yield simply seem to have better stocks to pick.
XPeng is one of several Chinese stocks that offer a play on the company’s electric vehicle market. The company went public just last month, and even with a recent pullback trades nicely above its $15 IPO price.
But with EV stocks in both the U.S. and China showing some weakness of late, XPEV might face additional near-term weakness. And as with PTR, there’s a real question as to whether investors have better choices elsewhere in the sector.
For XPEV, the peers are a pair of Chinese stocks. Nio (NYSE:NIO) has a market capitalization roughly twice that of XPeng — but sales that are 10x as high. Li Auto (NASDAQ:LI), another EV manufacturer, has roughly the same valuation despite sharply higher sales.
There’s an obvious irony to the fact that XPEV and PTR face similar questions. After all, optimism toward electric vehicle growth has played a role in the selling pressure on energy stocks like PTR. But these two very different stocks seem like they’re in the same boat at the moment.
I’ve recommended IQ stock at lower levels in the past — and I’m still not completely out on this story. iQiyi often is referred to as “the Netflix (NASDAQ:NFLX) of China,” and while that comparison isn’t entirely accurate, it does get to the heart of the IQ bull case.
Streaming video after all, is the future. And iQiyi has a massive population to serve, not just in China but elsewhere in Asia. That said, there are some concerns now that IQ has bounced back from May lows.
Valuation is one. iQiyi has a market capitalization near $17 billion, but isn’t profitable — or even close to it.
Competition is another. The company is going against Alibaba and Tencent (OTCMKTS:TCEHY), two of China’s biggest companies. Obviously, Netflix successfully took on giants, but iQiyi didn’t have the head start of its American quasi-counterpart.
Finally, there’s a potential overhang on the stock, given the disclosure of an investigation by the U.S. Securities and Exchange Commission. Given the losses suffered in Chinese frauds in recent years, it’s possible IQ stock won’t rally until that investigation is concluded one way or another.
Luckin Coffee (LKNCY)
Of course, one of the most famous of those frauds was the audacious revenue-inflated scheme executed by Luckin Coffee last year. Based on its reported numbers, Luckin looked like one of the country’s best growth stories, and a potential competitor to Starbucks (NASDAQ:SBUX).
That wasn’t actually the case, however. By the end of the accounting fraud, nearly half of Luckin’s revenue was faked. Luckin stock went from a high above $50 to below $2, and still sits under $3.
To some investors, the much-cheaper price might look like an opportunity. After all, not all of Luckin’s revenue was faked. The stores that dot China — over 4,000 of them — are real. New management perhaps can right the ship, and there’s enough cash on the balance sheet to allow the company to execute a turnaround.
But that case seems far too thin. As I argued after Luckin stock was delisted this summer, investors simply can’t trust the company. The cash balance, as recently reported, seems lower than it should be. And the stores might exist, but aren’t yet anywhere close to profitable.
On paper, there’s a way to see upside in LKNCY. That shouldn’t be, and isn’t, enough.
Shares of Internet retailer Mogu have seen some explosive gains this year — for reasons that remain unclear. There’s been very little news surrounding the company, and what news there has been looks mostly negative.
In the fiscal fourth quarter, for instance, revenue declined 45% year-over-year. The coronavirus pandemic was a factor (Mogu’s Q4 ends in March), and the apparel platform is focusing on its live video business at the expense of other revenue streams.
Still, that focus doesn’t explain why MOGU nearly quadrupled in a matter of sessions in late June. The stock has seen additional rallies which were less explosive — but faded just as quickly.
With Q1 revenue again down sharply (-46%), there simply isn’t that much to like here. If an Internet retailer is struggling now, when online shopping has seen rapid adoption, it’s hard to see when it might succeed.
Until Mogu inspires confidence that it can reverse these trends, MOGU stock likely isn’t going anywhere.
Kandi Technologies (KNDI)
Kandi stock too, recently saw a huge rally. In late July, KNDI went from $4 to $17. This rally, at least, was a little easier to understand.
Kandi announced its entrance into the U.S. electric vehicle market with 2 different models. The cheapest, the K27, will cost just $13,000 after federal tax credits. Given broader EV optimism, investors (and traders) quickly piled into the stock.
Most of the gains have receded, however, with KNDI back below $7. And there could be further downside ahead. Similar stories like Electrameccanica Vehicles (NASDAQ:SOLO) and Arcimoto (NASDAQ:FUV) have seen their own enormous rallies evaporate. EV manufacturing is a difficult, capital-intensive business, and as yet there’s been no sign that Americans are interested in the compact vehicles those companies are building.
Kandi, meanwhile, has teased before. The company has been public for over a decade, but before the recent rally had provided essentially zero returns to shareholders. Its EV ambitions stretch back years, but haven’t ever really delivered.
Kandi still has a lot to prove and even with the pullback, investors should keep that in mind.
GSX Techedu (GSX)
Online education platform GSX Techedu has been one of 2020’s best stocks. Even with a pullback of late, GSX stock still has rallied 347% this year.
In part because of those gains, GSX has become a target of short sellers. Among them is Andrew Left of Citron Research, who has uncovered other Chinese frauds. (It’s worth noting that Luck got Luckin wrong, however). Luck alleges that GSX is inflating users and revenue as well. And the claims hold up well to scrutiny.
Admittedly, there’s no smoking gun yet. But Luck is far from the only investor raising red flags. And after the Luckin disaster, investors would probably be wise to keep their guard up.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.