Today I did something that I never really imagined I would do: I bought shares of a Chinese company.
For years I’ve avoided Chinese equities. Government oversight and the lack of transparency with regard to financial statements has always been a deterrent. Certainly, the Chinese market is an interesting space. The Chinese population is much, much larger than the United States’. China’s middle class has grown leaps and bounds in the recent past and I expect for this trend to continue. The Chinese consumer is waking up and has tremendous buying power moving forward. U.S. companies realize this, which is why many are flocking across the Pacific, trying to carve out market share. But it’s not all rosy across the Pacific. There are debt concerns with the Chinese economy. I expect that China will have its fair share of growing pains as it attempts to grow its economy with a mixture of capitalist and communist policies. I’m not a student of historical economics, but I’m not sure if we’ve ever seen a situation like the one in China today from an ideological standpoint. I don’t know how it’s going to play out; will this country explode into the undeniable world economic power, or will it implode like a house of cards? Time will tell on those matters, but in the mean time, I’ve finally broken my anti-China rule with regard to companies domiciled in that county with a recent purchase of Alibaba (BABA) at $156.40.
I’ve watched all year as share of Alibaba have soared. This was a company I considered purchasing as a contrarian play after it sold off post-IPO. Without a doubt, BABA has massive growth potential. I don’t think anyone has ever doubted that. The fact that China’s consumption trends are rising alongside the rise of popular e-commerce platforms in very interesting to me. This county could end up essentially skipping the dense brick and mortar phase entirely, allowing for a much larger percentage of sales to happen online much quicker than it will in other, more developed economies. BABA is oftentimes referred to as China’s version of Amazon (AMZN), and while it has strong competition in the e-commerce space in its domestic market (probably much more so than AMZN has here in the U.S.), BABA’s potential addressable market is so large that I can imagine it becoming one of the world’s largest companies, if not the largest, in terms of market cap.
What’s more, shares have been trading very cheaply, especially compared to large e-commerce peers, such as AMZN. The market has been unwilling to place a premium on BABA shares because of the same government and transparency related issues that I mentioned in the introduction. I don’t know if China will ever truly open up its market and/or economy to the world and until it does so, these fears will likely persist. That said, as BABA continues to push forward as a public company, I suspect that trust within the market will slowly grow for the name, which will help the share price with regard to multiple expansion.
I didn’t buy shares in 2015 or 2016 (when they were much cheaper than they are today after the company’s 70% run up, YTD) because of my negative stance on Chinese equity. Obviously, I regret this now – but better late than never. I also worried about certain operational issues surrounding BABA, including the counterfeit issue that is oftentimes brought up and the company’s ability to transition from the consumer to consumer model to the more productive business to consumer model in terms of the majority if sales made on the platform. The risks just weren’t worth the rewards.
I still see the risks in the name, and frankly put, I can imagine a future where I lose half of my money here just as easily as I can imagine one where I double it. This isn’t the typical investment that I like to make, but I view purchasing BABA in a similar light as I do the American F.A.N.G. names; while they may be expensive in the present, massive upside remains due to the scalability of these internet related names. This is admittedly a speculative bet, but I have a portion of my portfolio set aside for such high growth bets and I’m happy to include BABA in that basket. After looking over recent 13f forms and watching as very intelligent and well-respected investors have piled into this name, I decided to join them in the trade with a very small percentage of my portfolio.
David Tepper’s Appaloosa Management and Dan Loeb’s Third Point Management both bought share stakes in BABA during the second quarter. Stan Drunkenmiller’s Duquesne Capital and Julian Robertson’s Tiger Management also bought shares, though not as heavily as Appaloosa and Third Point. Tepper and Drunkenmiller are both investors that I follow rather closely. Knowing that these men were willing to place such large bets on BABA increased my confidence in the name.
Before I get into my personal rationale behind the purchase (other than playing follow the leader with the hedge fund managers), I think it’s worth acknowledging the short-term mindset that many hedge fund managers use when making investment decisions. Following the hedge funds is not always a good idea. Sure, these leaders are smart investors, but they may not have goals that align with my own. Although I suspect that these men have confidence in BABA’s long-term potential as it attempts to dominate the e-commerce/cloud/logistics/payments/etc spaces, I wouldn’t be entirely surprised to see in a quarter or two that they’ve sold out, having chased the stock’s current run. Because of the fact that so many hedge funds have piled into the name, I also wouldn’t be surprised to see outsized volatility in the shares moving forward. Time will tell in that regard, but the way I see it, BABA has its hands in many potentially highly profitable/valuable cookie jars and this, combined with changing consumer trends in China, seem to bode well for the company long-term.
This potential for high volatility is why my initial purchase was a small one. Right now, BABA makes up 0.375% of my overall portfolio. I wouldn’t be opposed to moving this exposure up to the 1% range over time, but because of volatility concerns, I will continue to move into the name very slowly. Right now, my plan is to slowly build this position via monthly selective re-investments in the account which I originally purchased shares. Should BABA experience a significant sell-off, I will happily expedite the process with a cash purchase.
Generally, I’m not a big fan of buying shares near 52-week highs. I’d much rather be buying them when they’re cheap. But barring a major sell-off, I don’t see BABA being cheap anytime soon, and this is one of those buys where I’m simply holding my nose and jumping into the stock. When purchasing shares of a company like this an investor is putting faith in the company’s above average future growth rate. Revenue growth for BABA has been very impressive during the past 5 years. The top line growth trend for this company appears to be slowing, but that’s to be expected for a company of its size. I still expect BABA to increase sales in the 30+% range over the short-term and wouldn’t be surprised to see strong double digit growth for years and years (if not decades) to come. Like AMZN, profitability doesn’t seem to be the concern yet with BABA, but during these early stages of the game, I don’t blame the company for focusing on market share growth. Jack Ma seems to be a competent leader and while I admit that an investment in BABA isn’t one based entirely upon the fundamentals, I’m happy to partner with an innovative mind like his.
One aspect of BABA that attracted me to the stock was its apparent ability to trade without correlation to the U.S. market. BABA doesn’t seem to be correlated to the SPY or the DOW, which is a nice differentiator for my portfolio which is made primarily of large cap US names. I’m oftentimes looking for potential hedges and/or alternative investments that aren’t correlated with the major U.S. indexes and I think BABA helps to fill this niche for me.
What’s more, one of my biggest concerns for the market at the moment is a possible trade war breaking out between the U.S. and China. Many of the DGI names that I own are large, multinational companies with significant exposure to the Chinese economy. If policies were put into place, on either side of the Pacific, that hurt this portion of their business it would surely effect the top and bottom lines. Also, several of the companies that I own have focused much of their future growth on the Chinese market. A company like Starbucks (SBUX) comes to mind here. SBUX is one of my larger holdings, and if its plans in China were derailed by a potential trade war, I would stand to lose a great deal of money because I’m sure that the market would rerate SBUX shares, significantly lowering the premium it is willing to pay for them. This same scenario could turn out to be true for a large percentage of my portfolio. I don’t know how likely a trade war is because both the U.S. and China hold impressive financial leverage over the other. I’m sure both countries would lose, in the short-term, at least. Politicians, like hedge fund managers, rarely seem to have long-term mindsets these days, making these policies exceedingly difficult to implement. Regardless, I see BABA as a potential hedge to many of my multinational holdings. This is one of the reasons that I hope to increase exposure to this name moving forward.
For so long I’ve been very content with a portfolio nearly 100% concentrated in U.S. equities; however, due to the seemingly endless uproar that is being created by the White House, which is making productive policy changes in Washington more and more unlikely, it seems to me that increasing my international holdings is a good idea. I wasn’t a Trump supporter during the election, I’ve made this clear. But I did think that the silver lining of the Republican sweep was that tax reform (something that this country is in dire need of) would get done. I’ve positioned myself in a way that should lead to significant profits should tax reform take place. But with divisiveness growing on Capitol Hill and individuals from both the public and private sectors distancing themselves from the President, I think it’s now unlikely that we’ll see any major, overarching reform. Now I just have to hope for repatriation or a simple tax cut, but I don’t know if there will be enough support for those measures in today’s political environment. Needless to say, this turmoil in Washington is not a good thing for the American economy (an economy that I’ve been tremendously bullish on for years). The private sector posted quality earnings in the second quarter and I’m sure companies will continue to push forward on their own, but without pro-business policy coming out of the current administration, I worry that multiples are too high domestically. Multiples are lower in Asia and in Europe; I’m looking at ways to increase my exposure to those markets.
BABA reports earnings on Thursday. There have been several bullish notes out on the stock today and I’m looking forward to the results. The implied volatility in the options market is current pointing to a ~6% move. This stock isn’t for the faint of heart, but as I said before, I like the upside potential and I’m happy to hold it in my growth basket alongside other non-dividend paying companies such as Amazon, Alphabet (GOOGL), Facebook (FB), Celgene (CELG), Regeneron (REGN), and then low yielders like NVIDIA (NVDA), Visa (V), MasterCard (MA), and Expedia (EXPE). These companies don’t contribute much to my income stream in the present, but I hope that in the future they will have fueled the overall growth of my nest egg to the point where I can retire earlier than previously imagined. After recently cashing in my large Time Warner Inc (TWX) position and using the majority of the proceeds to buy more conservative companies such as AT&T (T), United Parcel Services (UPS), FedEx (FDX), and Union Pacific (UNP), I felt comfortable increasing the risk profile of my overall portfolio by adding shares of BABA. Even after my BABA buy, I still have a bit of cash leftover from the TWX sale as well as the proceeds from the profits I recently took with Altria (MO), so I’m still in a nice position to make another purchase or two without dipping into the cash that I’ve set aside for the next significant market downturn.
Disclosure: I am/we are long BABA, AMZN, T, UNP, UPS, FDX, CELG, EXPE, FB, GOOGL, MA, V, NVDA, REGN, MO, SBUX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.