Alibaba (BABA) and Baidu (BIDU) offer tempting risk / reward ratio at these levels



VSChinese internet stocks took a hit. The big names are all down at least fifty percent from their peaks amid increased regulation, or at least heightened rhetoric, from the country’s rulers targeting the rich and powerful suppliers research and e-commerce services to Chinese such as Alibaba and Baidu. Searching for a bottom on the drop has been a dangerous game so far, but there are reasons, both logical and technical, to believe that disciplined play in either of these names is a risk worth taking at this point.

Alibaba (BABA) was hit as early as last October, when it became increasingly clear that the Chinese Communist Party had taken a dislike for the company and its founder, Jack Ma, but it turned out that the antipathy went beyond Ma. Initially, the other big market player, Baidu (BIDU) took advantage of the increasingly hostile remarks against Alibaba and the share nearly tripled when BABA fell from its peaks. By the end of February, however, it was clear that it wasn’t just Jack Ma who was shaking the Party, and BIDU came back to earth with a bump.

2 year / 1 day charts for BABA (top) and BIDU (bottom)

2 year / 1 day chart for BIDU

It seemed that traders and investors had forgotten that despite its membership in big business, China was still a totalitarian country and its markets were far from “free”. More importantly, it seems Ma forgot about it as well. He had become more vocal on topics that went beyond his own business, and that visibility undoubtedly had an impact, but it was the growth of the financial side of the business and Ant Group’s attempted IPO which turned out to be the tipping point.

Remember, China’s rulers are familiar with Marxist theory, so they’re all too aware of the relationship between money and power – and they care about power. Allowing a private company to have control of finances and store massive amounts of data on the Chinese population doesn’t make sense to them no matter how happy people are with their newfound wealth. Some flexibility in government was inevitable, but keeping the people happy is also fundamental to the Party’s grip on power. Removing Internet freedoms that the Chinese have become accustomed to would also be dangerous. Everything must be seen through the prism of maintaining power. Nothing else matters.

The logical result of all of this is that companies like Baidu and Alibaba would get a harsh discussion and be reminded not to exceed limits, but then be allowed to get back to work. They might have their wings cut a bit when it comes to their expansion plans, but they would still be allowed to do business. The question for potential investors then becomes, should you buy BIDU and BABA based on their existing business and organic growth expectations rather than the prospect of buyouts and expansion?

The answer at current levels is yes, provided you stay disciplined.

Even though companies like Alibaba and Baidu face a more restrictive environment than they are used to in some ways, they are still lucrative machines that exist in a huge and ever growing market. Alibaba has earned just under $ 300 billion in the past twelve months, while Baidu has earned over $ 53 billion. Both have huge free cash flow and large liquidity reserves designed to provide a buffer against the still uncertain political and regulatory environment in which they operate. History suggests this is smart, but normal service will resume once they are reminded of their position in the system.

In the long run, therefore, these stocks are a buy, and now is a good time to play safe and structured play to potentially benefit from them. Both have bounced off their lows recently. This doesn’t necessarily mean that the strong downtrend is broken, but the fact that those lows are roughly at the levels reached before Covid and before the big post-Covid market jumps makes it likely. These recent lows also create a logical level below which to set a stop-loss order, and that’s an important part of the equation here. There are logical and historical reasons to believe that the Chinese government will act rationally (again, bearing in mind that everything must be seen through the prism of power), but this is never guaranteed in an opaque one-party system of government.

At some point, BABA, BIDU and other Chinese internet stocks will recover, and the proximity of levels before the post-covid surge makes it more likely that the recovery will start soon. Buying here, therefore, with stops just below recent lows that are set, and of course respected, looks like a high risk / high reward trade that has a decent chance of success.

* Disclaimer: The author puts his money where his mouth is and buys BABA and BIDU this morning, so both actions will likely be long when you read this.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



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