Are These Neglected Chinese Stocks a Buy?

BY MICHAEL SALVATORE, EDITOR, TRADESMITH DAILY

In March 2020, one hedge fund manager took on an obscenely risky position to leverage a unique moment in history.

The stock market was just beginning a one-way trip higher in the wake of the Federal Reserve’s generous pandemic response.

Trillions in liquidity meant making money over the next year would be almost too easy.

But while that hedge fund manager’s tactics worked for a while… they came crashing down a year later… and he took a few stocks with him.

His name is Bill Hwang: a Korean-American investor who had set up a “family office” called Archegos Capital Management at the time. (I use sneer quotes because this family office operated a lot more like a hedge fund, just with fewer regulations.)

At one point, Archegos managed over $36 billion – much of it in a handful of single stock positions. Many of those companies are solid, as we’ll see in a bit, but the positions were highly leveraged. And that’s where he got into trouble.

Alongside Hwang’s personal fortune, Archegos borrowed billions from a dozen different banks to build up these positions. Further, they used complex derivatives trades to amplify their market exposure (risk) from a starting point of $10 billion to more than $160 billion at the peak.

This went on until March 26, 2021: The day Archegos got margin-called into financial oblivion.

A Cautionary Tale… and an Opportunity

Bloomberg reports that Hwang personally lost $20 billion in just two days, as key stock positions in ViacomCBS and Discovery Inc. lost more than a quarter of their value within a week and triggered the margin call.

Archegos’ creditors – Credit Suisse, Nomura Holdings, Goldman Sachs, and Morgan Stanley, among others – all faced massive losses. Archegos was forced to liquidate billions’ worth of stocks to attempt to meet their obligations.

They didn’t. The losses among Archegos’ lenders were over $8.3 billion. The impact on the stocks Archegos held was significant – with some just narrowly avoiding bankruptcy.

This past week, Bill Hwang stood trial against accusations of securities fraud, wire fraud, and racketeering conspiracy in connection with the blowup. The wheels of justice are still turning, with the trial set to take as long as eight weeks. In all likelihood, Bill Hwang will serve time.

Now, why am I telling you this story?

For one, it’s a cautionary tale against leverage. No matter how right you think you are, the market has a funny habit of humbling the overconfident. When you use and abuse leverage, losses can quickly spiral out of control.

But the far bigger thing on our mind is some of the stocks Archegos was forced to liquidate… and where they are today.

Should You Buy Archegos’ Casualties?

ViacomCBS and Discovery – now both since acquired by larger media companies – were the headliners of the Archegos story. But they weren’t the only affected stocks.

Aside from being bullish on media streaming, Bill Hwang had a penchant for Chinese tech companies… and he had one clothing brand in the mix, too. Here’s a look at how the rest of Archegos’ portfolio has done since March 2021:

As you can see, during the run-up to the crash, almost all of Archegos’ core holdings were outperforming the S&P 500. Since the crash, though, they’ve all lagged significantly. Clothing brand Farfetch (FTCHF) now trades over the counter with a valuation of less than $1 million. GSX Techedu (GOTU) suffered not just the Archegos capital blowup but also the Chinese government cracking down on the entire for-profit education industry there.

But let’s focus on a few of the survivors in the Chinese tech space: Tencent Music Entertainment (TME), Vipshop (VIPS), Baidu (BIDU), Gaotu Techedu (GOTU), and iQIYI (IQ).

Each of these stocks are Chinese tech companies – a very hot trade leading up to the Archegos debacle and basically toxic afterward.

Seeing the trial this week, and remembering the Archegos blowup from 2021, it got me curious about whether these stocks are buys.

Now, we could roll up our sleeves and start studying balance sheets and charts to figure it out. Or we can see the three most important factors – fundamental strength, technical health, and the signs of big institutional capital – and combine them into one simple number.

Regular readers will guess I’m talking about Jason Bodner’s Quantum Score – a composite rating that highlights stocks in the “sweet spot” of those three factors.

Stocks that rate between 70 and 85 on the Quantum Score are part of an elite class of companies that, had you held them exclusively over the past 25 years, would’ve outperformed the S&P 500 7-to-1.

Let’s take a look at those five Chinese tech companies and see how they rate…

How the Quantum Score Rates These 5 Chinese Techs

1. Tencent Music Entertainment (TME)

First up is Tencent Music Entertainment (TME), a subsidiary of the broader Tencent entertainment group and what’s essentially the Spotify of China.

On Jason’s Quantum Score, TME earns a place right in the middle of the sweet spot… with an especially hot, even dangerously hot technical score owing to its recent momentum (shares are up 78% year-to-date, well outpacing the market):

TME isn’t cheap at 34 times forward earnings, but it is earnings-positive, which we can’t say about Spotify (SPOT). This is one to keep an eye on for a pullback. A technical score that high means we shouldn’t chase the stock at these prices.

2. Vipshop (VIPS)

Vipshop (VIPS) is the third-largest e-commerce brand in China. It’s also the largest in the discount retailer segment, with over 38% market share. If we compare China’s largest e-commerce giant JD.com to something like Amazon.com, Vipshop might fill a space closer to Walmart.

VIPS caught my eye for its Thursday performance, which saw it rise over 3% on the day. It’s also quite cheap for its segment, trading at just 8.5 times forward earnings. The company also recently declared its first dividend at $0.41 per share.

Taking it over to the Quantum score, however, we get a less-ideal picture.

The Quantum Score gives VIPS a 48.3 – not terrible, but not in the sweet spot that would flag a buy signal.

The biggest ding is on the technical score. VIPS’ share price has been largely flat for the past year. In layman’s terms, it’s not a “winner” stock that lots of investors want to buy. It’s acting like a stable steady-eddy name, but without the commanding market share or market cap to back that up.

Jason’s system is tuned for growth opportunities – he wants to see earnings and revenue growing year after year, alongside strong institutional support. We’re not seeing that with VIPS, at least not right now.

3. Baidu (BIDU)

Next, let’s look at Baidu (BIDU). This was another of the favorites from the Chinese tech trade in early 2021. The stock ran over 150% higher in the three months between November 2020 and February 2021, before Archegos sent it on a roundtrip. Today, the stock trades more than two-thirds below its all-time high set during that time.

Similar to VIPS, we can think of Baidu as the Google of China. It’s the dominant search-engine player in the region – especially since China’s internet is restricted from accessing Western services – and offers a number of other internet services, including cloud and AI.

It’s also something of an earnings rockstar. Since July 2015, the company has beaten every single one of its quarterly earnings estimates. It’s not a fast grower, though, with a five-year compound annual growth rate of just 5.3%.

That slow growth rate may be contributing to Jason’s Quantum Edge score:

BIDU manages to match VIPS on the Quantum Score, with a slightly higher fundamental score making up for a slightly worse technical score.

From a growth-investing perspective, this just isn’t showing the kind of buy signal you’d want to see.

As I mentioned, the sweet spot is when the overall Quantum Score gets up into the 70-to-85 range. And while there are lots of technical factors we can– and do – use, Jason’s technical score revolves around big money buying.

4. Gaotu Techedu (GOTU)

Gaotu Techedu (GOTU), formerly GSX Techedu, is an especially interesting case. It’s one of the worst casualties of the Archegos collapse, but it’s also one of the best performers recently. It’s up more than 150% year-to-date.

Archegos was the first punch, but the second came just four months later, when the Chinese government cracked down on the then-$100 billion private education sector.

Now, though, GOTU appears to be recovering from the fallout of 2021. And this year’s momentum is giving GOTU an edge on the Quantum Edge score, bringing it closer to a buy signal:

5. iQIYI (IQ)

Finally we have iQIYI, a video- and entertainment-streaming company similar to Hulu or Netflix here at home. This is another one of the major casualties from the Archegos blowup, down more than 78% from its peak.

Today, though, it earns a rare buy signal from Jason’s Quantum Edge score.

IQ earns a 74.1 on the Quantum Score, right in the middle of the sweet spot that flashes a buy signal. Its technical score is a huge factor here, even as shares are up just 14% year-to-date, signaling the likely presence of big institutional buying.

As billion-dollar funds move into these stocks, that’s when the magic tends to happen for their stock price. Archegos is one of the most dramatic examples, but this dynamic plays out in the market every single day.

Jason is particularly adept at spotting it… since he used to be the professional trader tasked with buying (lots of) shares for institutions on the downlow.

Jason reports his findings to subscribers every Monday in Quantum Edge Pro, and his Quantum Scores are available in the TradeSmith Finance dashboard as well. Click here to learn more if you’d like his help navigating the big-money-driven market.

To your health and wealth,

Michael Salvatore
Editor, TradeSmith Daily