Chinese tech stocks retain appeal after rally

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Cheap valuations of Chinese technology stocks are attracting more investors after an earnings season characterized by better profits, more buybacks and dividends.

Analysts have raised forward earnings estimates for the Hang Seng Tech Index to a three-year high after Tencent Holdings Ltd. and others generated better-than-expected profits. The results, which come after Beijing eased its years of regulatory crackdown, suggest that shares of Chinese technology companies may have reached an all-time low.

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Some investors have already returned to this battered sector, pushing the Hang Seng technology index up 33% since the end of January. Even after that period, the metric that tracks China’s top tech companies trades at less than 17 times forward earnings, compared to a five-year average of 26 times. The Nasdaq 100 is currently at 26 times.

“Chinese tech stocks still look attractively valued in my opinion, and I think we are far from reaching the top,” said Jian Shi Cortesi, fund manager at GAM Investment Management. “Many Chinese technology companies have seen their profits increase in recent quarters, and investors are finally paying attention. »

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China’s tech index is still more than 60% off its 2021 peak. Its sharp decline has pushed valuations to multi-year lows, but concerns about Beijing’s policies and slowing economic growth had previously kept investors away. In recent months, policymakers have increasingly supported the economy and said technology companies will help spur innovation.

Tencent is on track for its longest streak of monthly share price gains since 2018. Last week, the company reported a 62% increase in quarterly profit as advertising sales through its video service TikTok style have doubled. Analysts have raised its average price target by 9% since the earnings release, expecting a recovery in gaming activity this quarter to send the stock higher.

Rival e-commerce operator JD.com Inc. and Internet search leader Baidu Inc. also delivered better-than-expected profits. GAM Investment’s Cortesi cited better cost controls, “more rational competition” and investment discipline as reasons for the strong results, adding that rising shareholder returns are also positive for stocks.

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Shareholders benefit from better profits. Buyouts by Tencent, Alibaba Group Holding Ltd., JD.com, Meituan and Baidu could reach a record total of $28 billion in 2024, up from less than $20 billion in 2023, according to Bloomberg Intelligence. Dividends are expected to total $10 billion from $8.3 billion, BI estimates.

Cautious Chinese consumers and competition from new entrants remain challenges for technology companies, as Alibaba’s disappointing figures show. But there are signs that excessive pessimism is fading, with Alibaba’s three-month volatility asymmetry falling to its lowest level since 2021, indicating reduced investor demand for downside protections.

Results from e-commerce operator PDD Holdings Inc. and major gaming company NetEase Inc. later this week will provide further insight into the consumption recovery. The Chinese government could provide further catalyst through support measures, although investors remain wary after previous regulatory crackdowns and the latest trade tensions with the United States and the European Union.

There is still room for improvement in technology stocks despite the “geopolitical noise” weighing on Chinese stocks, according to Xiadong Bao, fund manager at Edmond de Rothschild Asset Management. “I think the rally could still make sense given their attractive valuation relative to US tech names, light positioning from global investors and improving fundamentals.”