Stocks of some of China's most widely held companies were sinking in unison on Wednesday, with several catalysts sending them lower. One company delivered a disappointing financial report, concerns about China's economy continued, and the country's policymakers announced moves that shook up its stock market.
With that as a backdrop, several of China's biggest technology stocks lagged the broader market. Shares of Baidu (NASDAQ: BIDU) slumped 7.2%, Tencent Holdings(OTC: TCEHY) declined 3.9%, and Alibaba (NYSE: BABA) fell 3.4%, as of 1:22 p.m. ET today.
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Disappointing results
Baidu reported its fourth-quarter results, and investors were not pleased. The company generated revenue of $4.9 billion, up 6% year over year, while the diluted earnings per American depositary share (ADS) of $0.95 cratered 50%.
To give those numbers context, analysts' consensus estimates were calling for revenue of $4.86 billion and per-ADS earnings of $2.48, so profits fell far short of investor expectations.
The news wasn't all bad, as Baidu's ChatGPT-style offering, ERNIE, helped boost revenue, despite an ongoing downturn in advertising, which is the company's bread and butter. On the other hand, steep spending on artificial intelligence (AI) helped erode the bottom line, weighing on profits.
The company noted that revenue from its core business, which consists mainly of online advertising, cloud computing, and AI, grew 7% to $3.87 billion, while growth at its streaming platform iQiyi lagged, increasing 2% to $1.1 billion.
A weak economic backdrop
Baidu is the latest company to report earnings that highlight the current challenges besetting China's economy. The country is suffering from high unemployment among younger citizens, slowing growth, and lower consumer spending.
Any economist will tell you that consumer spending is the backbone of an economy, so this could be a bad harbinger.
Exacerbating the situation is the crisis in China's real estate market. Just last month, a judge ordered the liquidation of property developer China Evergrande Group, which helps illustrate the ongoing challenges in the country as property transactions have slumped.
Last year, home sales in China declined 6.5%, and market commentators suggest the worst isn't over. By some accounts, real estate represents roughly 25% of China's economy, which just makes things worse.
Lastly, the country's moves to curb certain investing strategies are not being well received. Chinese securities regulators announced a crackdown on short-selling, going so far as to say that malicious short-sellers would "lose their shirts and rot in jail," according to a report by Reuters.
China also announced curbs on quantitative or computer-driven trading. Regulators directed quant funds to stop accepting new cash and discontinue existing "direct market access" products. These recent moves have cast a pall on the market, helping send these popular stocks lower.
Will investors follow the government's lead?
Investors already leery about the worsening economy in China have more reasons to be wary. Furthermore, each of our trio of companies listed above is highly dependent on consumer spending and a strong economy:
- Baidu is China's leading internet search provider, and like Alphabet's Google -- its U.S. counterpart -- it relies on digital advertising for the vast majority of its revenue. Weakness in the economy translates to much lower ad sales.
- Alibaba is one of the country's largest digital retailers. Lower consumer spending equals less sales.
- Tencent's social media makes much of its money from advertising, while its gaming and ancillary services are highly dependent on consumer discretionary income.
In the face of macroeconomic headwinds and high unemployment, consumer spending in China is slowing, which could further weaken an already fragile economy. As a result, the future is uncertain, particularly for companies that depend on consumers for their livelihoods.
To be clear, I'm not suggesting investors should avoid these stocks completely. In fact, they are currently trading at compelling valuations, as Alibaba, Tencent, and Baidu are selling for 14 times, 12 times, and 12 times earnings, respectively -- each a significant discount to the broader market. And Baidu and Alibaba are selling for a price-to-sales ratio of less than 2, the benchmark for underpriced stocks.
That said, investors should factor China's weakening economic outlook into their thinking and ensure they approach these companies with a long-term outlook.
Furthermore, investing in China carries additional risk, and any position should be a modest part of a well-diversified portfolio.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Danny Vena has positions in Alphabet, Baidu, and Tencent. The Motley Fool has positions in and recommends Alphabet, Baidu, and Tencent. The Motley Fool recommends Alibaba Group and iQIYI. The Motley Fool has a disclosure policy.
