For the past decade, the Chinese stock market has underperformed US stocks. Since February 2011, the Shanghai Stock Exchange is up 30%, while the S&P 500 is up 205%. Of course, this follows a “lost decade” for US stocks, when the Shanghai Stock Exchange experienced a decade-long bull market.

Intra-market relationships tend to be mean-reverting, so it wouldn’t be surprising for Chinese stocks to outperform this decade. The major reasons are that the Chinese economy has expanded at a close to a 7% pace over the last decade and is forecast to expand at a 5% rate over the next decade. In contrast, the US averaged 2% economic growth over the past decade, and most expect similar growth rates over the next decade.

Further, the Chinese economy is maturing and increasingly become a consumer-led economy. Historically, China has been an export-dominated economy, so its growth has been dependent on other countries buying their products which means the country is more exposed to the vagaries of boom-and-bust cycles. 

While the country’s dependence on export was a hindrance over the past decade, it could be an accelerant in the next couple of years. The last ISM report showed that the manufacturing sector is doing very well. Further, it showed that inventories are at multiyear lows, while New Orders are near multiyear highs. Readings are consistent with previous multiyear expansions.

Given the short-term and long-term catalysts for Chinese stocks, investors should pay attention to Chinese stocks. Four of the top Chinese stocks to consider buying is Baidu (BIDU), NetEase (NTES), Finvolution Group (FINV), and China Online Education Group (COE). 

Baidu (BIDU)

BIDU’s core business is Internet search, and it’s the dominant search engine in China with an 80% market share. This business drove Baidu’s stock to a 6,040% gain between its IPO in August 2005 to July 2011. From July 2011 to March 2020, Baidu’s stock declined by 50% as investors were infatuated with other Chinese Internet stocks growing at faster rates like Alibaba (BABA) and Tencent (TCEHY).
Over this period, while BIDU’s stock price was flat, its business continued to grow. For example, revenues on a trailing twelve-month basis went from $1.9 billion to $18 billion. Net income went from $400 million to $4 billion. Equally important, the company made strategic investments in future growth industries like cloud computing, AI, AV, and EV driving. Shares are 35% higher this year following the company’s news of a joint venture with Geely (GELYY) to produce autonomous, electric vehicles. 

These moves have, once again, got investors excited about BIDU’s growth potential which is evident from its multiple expansion in recent months. Despite recent gains, BIDU’s valuation is reasonable compared to its peers. 

The POWR Ratings are also constrictive on BIDU as it is rated a B which equates to a Buy rating. The POWR Ratings are calculated by weighing 118 different factors, each with its own weighting. Stocks are further evaluated across eight different components. 

It’s also not surprising that BIDU has a B for Momentum. On short-term timeframes, momentum stocks tend to outperform as objects “in motion, stay in motion”. BIDU has also benefitted from a variety of catalysts including positive news about its autonomous driving software, rumors about interest in EVs being true, and news of its joint venture with Geely.

If you are interested in learning about the other components of BIDU that the POWR Ratings evaluates including Quality, Stability, Sentiment, Value, Growth, and Industry, then click here.  

FinVolution Group (FINV)

FINV has been one of the best stocks in 2021 with a 131% gain to start the year. FINV operates a fintech platform that provides financial services to underbanked consumers. Its primary revenue stream is from making loans to consumers. As of the start of the year, it had 110 million registered users. 

FINV is very cheap given its PE ratio of 5.8. Further, it’s quite profitable with 83% gross margins and 26% profit margins. These high margins are a result of the company’s business model which is essentially to be a middle-man between consumers and financial institutions.

Some recent catalysts include the company choosing to focus on customers with better credit ratings and a lower than expected delinquency rate. There were some concerns that due to COVID, default rates would be higher than normal. However, this hasn’t happened, and no spike is expected now that the Chinese economy is reopening.

The POWR Ratings rate FINV a B which equates to a Buy. It’s not surprising that it’s graded a B for Value given that its PE and PS multiples are well below its peers in the consumer finance space and the broader market. Some more multiple expansion is likely if loan volume remains growing, while default rates remain low.

NetEase (NTES)

NTES develops and operates mobile and PC games, communities, and eCommerce platforms. Its titles include some of the most popular games in China such as the Westward Journey series, Ghost, and partnering with Activision Blizzard (ATVI) to deliver Chinese-versions of Blizzard games to its users. 

NTES became a public company in 2000. Since then, the video game industry has gone from a $20 billion industry to be worth nearly $200 billion. NTES has ridden this wave to become one of the most valuable video game companies in the world. It’s looking to maintain its standing as one of the leading gaming companies in China with new products including a VR-based, open-world, role-playing game that is highly anticipated by the gaming community.

Over the last ten years, NTES’s revenue has gone from $780 million to $8.7 billion. Next year, earnings are expected to grow by 60% and revenues by 27%. Due to this, NTES has a reasonable forward PE of 30. 

The POWR Ratings are constructive on NTES as it has a B rating which equates to a Buy. In terms of Growth, it also has a B. This is consistent with NTES’s leading position in the video game market which is expected to grow at a double-digit CAGR over the next decade. NTES also has shown the ability to develop and launch new games that are well-received by the public and partner with foreign developers to bring popular games to the Chinese market. 

China Online Education Group (COE)

From its IPO in 2016 to late 2019, COE declined by 75%. The stock was negatively impacted by rumors of accounting fraud due to companies like Tal Education and Luckin Coffee of which COE shared an auditor.

In hindsight, that was a buying opportunity as shares are up five-fold since then. As a provider of online English education to students in China and the Philippines, the company was a clear beneficiary of the coronavirus. As a result, the stock price shot up from $6 to $36 during the first round of lockdowns in China in anticipation of a boost in sales and earnings.

Since then, the stock has largely consolidated in a range between $20 and $30. However, recent earnings reports have been quite strong which indicates that the stock is likely to break out higher from this range. We’ve already seen strength in other Chinese online education stocks in recent weeks including New Oriental Education (EDU) and GSX Techedu (GSX). 

Over the past year, revenue has increased from $57 million to $79 million. Gross profit has increased from $40 million to nearly $60 million. However, the company’s forecasted growth is what makes COE attractive. In the last year, COE earned $0.76 per share. This is expected to increase to $7.70 next year which would give it a forward PE of 3.3. If COE can achieve this growth rate, then its shares are likely undervalued and will see more gains in 2021.

The POWR Ratings rates COE an A which equates to a Strong Buy. This isn’t entirely surprising given that it’s attractive from a growth and value perspective. COE also has a B for Quality. COE is one of the leading online education companies in China. Spending on education in China continues to increase at a double-digit rate. Additionally, COE is targeting non-Tier-1 cities, where there is less competition. 

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BIDU shares closed at $313.00 on Friday, up $3.41 (+1.10%). Year-to-date, BIDU has gained 44.75%, versus a 5.02% rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...

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