China has grown from a relatively poor communist company to become one of the most influential countries in the world. The country’s economy has been on a strong growth path, helped by its large, well-educated, and young population.
The government’s transition to a market-based economy has also helped substantially. This growth has led to the country having more than 1,000 billionaires, the most of any country. In this article, we will look at how to invest in China stocks, and the risks are involved.
Why invest in China stocks
There are several benefits of investing in China. First, it is the fastest-growing major economy. For example, it managed to record economic growth in 2020 even as other countries like the United States and the European Union contracted. This growth was helped by strong internal consumption and faster external growth.
Second, while the Chinese economy has grown substantially, it has more room to grow. For example, while the tech sector has grown rapidly over the years, many sectors are still young. Therefore, investing in the country will help you benefit from some of these trends.
Third, many Chinese stocks are relatively cheaper compared to western equities. For example, while the S&P 500 index has an average PE ratio of 43, the Shanghai composite index has a PE of less than 25.
Finally, the growth of the Chinese economy, coupled with the large population growth, are reasons to be bullish on the Chinese economy.
Risks of investing in Chinese equities
While China offers substantial opportunities, there are several risks that come up when you are investing in the country.
First, there are regulatory issues from the country. In 2021, Chinese regulators started to focus on several sectors like e-commerce, gaming, gambling, and education. For example, they ordered their tech giants like Alibaba, JD, and Tencent to share data with each other.
They also ordered food delivery companies like Meituan to treat their riders as employees. Further, they placed strict rules on companies providing educational services. As a result, as shown below, these stocks underperformed substantially.
Alibaba, DiDi, JD, Tencent shares
While regulatory issues are common globally, those in China are unique because regulators have the final say on most things. This is unlike in the US, where a company can sue the government to block an order by a regulator.
Second, there are regulatory risks coming from the American government as well. In the past few years, tensions between China and the US have grown. As a result, there is pressure from regulators and policymakers about blocking Chinese companies that don’t comply with American laws. Indeed, the SEC has warned that it could delist hundreds of Chinese companies.
Third, there are risks of research. As an investor, it is important that you do intensive research about the company that you are investing in. To do this, you need accurate data sources like well-audited financial statements such as income statements, balance sheets, and cash flow statements. The challenge of investing in China stocks is that this information tends to be limited. Also, it is hard to trust some of the documents from Chinese firms.
How to invest in Chinese stocks
There are three main ways of investing in Chinese stocks for most Americans. First, you could invest directly in Chinese firms that are listed in American exchanges. There are hundreds of these companies, with the most popular ones being DiDi, Alibaba, Nio, Baidu, and Pinduoduo. The process of investing in these firms is relatively simple since all you need is access to a good broker like Robinhood and Schwab.
Second, you could invest directly in Chinese stocks listed overseas in places like Hong Kong. To do this, you will need access to a broker who lists these companies. Interactive Brokers is one of the biggest American brokers that offer offshore listings. Still, the challenge is that many of these stocks are not offered in dollars.
Finally, instead of investing in individual stocks, you could invest in exchange-traded funds (ETFs) that track Chinese companies. For starters, an ETF is a fund made up of several companies. As such, it is investing in these funds gives you exposure to tens or hundreds of companies at once. Some of the most popular China-focused ETFs are iShares MSCI China ETF, iShares Large-Cap ETF, SPDR S&P China ETF, and Invesco Golden Dragon China ETF.
China stock picks
While risks exist, there are many popular Chinese stocks that you can invest in. Besides, the ongoing risks posed by regulations have made many of these firms relatively cheaper compared to their peers. Some of the top Chinese stocks to invest in are listed below.
Alibaba is a leading e-commerce and cloud computing company. It is made up of several companies like Alibaba Cloud, TMall, and AliExpress, among others. It is a good investment because of its large market share, strong growth, and valuation. For example, the company has a market capitalization of more than $500 billion while Amazon is valued at more than $1.5 trillion. Yet Alibaba is more profitable than Amazon.
DiDi has performed badly as a public company. Its total market capitalization is at about $40 billion. Yet it has more customers than a company like Uber that has a market cap of more than $74 billion. It also has a bigger runway for growth than Uber.
Tencent is a tech company that many Americans don’t know about. Yet many of them have used some of its products like WeChat, Fortnite, and League of Legends. It also owns some popular brands in China like QQ, Tencent Sports, and Tencent Pictures. It is also the biggest video and mobile game company in the world. You can invest in Tencent in the Over-the-Counter (OTC) market.
Investing in China stocks is a high-risk and high reward situation. While it is risky to do so, these stocks have substantial room to grow. Therefore, we recommend that you allocate some of your money to growing companies from the country.