Dylan Lewis: Welcome to Motley Fool HQ!
I’m Dylan Lewis, and I’ll be your host today. I’m joined by analysts
Emily Flippen and Bill Mann. We’re going to be talking all things China
on this broadcast, breaking down the story over the last couple of years from a macroeconomic
perspective, some more recent developments with the trade war, and of course, we’ll be
talking about some stocks that people should be putting on their watch lists.
We can’t do a broadcast without doing that. Of course, if you are looking for some stocks
to get started, we have an investing starter kit. You can get that over at fool.com/start.
It’s free. Five stocks, great for beginners. Let’s get started with
this China discussion. One of the things that is interesting with
China is, for a very long time, there was a crazy growth story going on. We were seeing
double-digit GDP growth in China. That slowed a little bit
after the financial crisis. We’re seeing things
in the single digits. But there have been a lot of
big macro stories with this country. What have you seen, Bill? Bill Mann: China to me is the greatest
growth story that has ever happened. What they have done from 1970 until,
call it 2015, was unprecedented. Bringing 12% of the world’s population out of poverty
and into at least middle class. It’s really amazing. But they did it as an export economy.
Everything that China did was geared towards exports. At some point, you cannot grow at 12% if your
export targets are growing at 3% and 4%. Those numbers become hard. China over the last few years has been quite
aware of this, has been trying to bring up and incentivize domestic consumption.
They’ve succeeded to some degree. But it’s pretty clear that this is a much harder thing
to achieve than even what they’ve done to date. Lewis: You mentioned the
demographic shifts that we’re seeing. Another big narrative with China is this
idea that we have a rising middle class. We have purchasing power increasing in
the country. Has that narrative held? Is that something that you
guys are continuing to see? Emily? Emily Flippen: Maybe not
when you look at GDP growth alone. But when you look internally in China,
you see a generation of people that have a stronger proclivity to spend, as opposed
to the generations before them. My favorite generation to look at
in China is actually the Generation Z. That’s the generation
right after millennials. We see this generation spending more and more
money on stuff that generations before them never spent money on. VAS revenue is a big driver of
revenue for a lot of Chinese companies. That’s a value-added service revenue.
Mann: I’m so glad you defined that. Flippen: This is a type of revenue
that’s going over live streams. So, you’re watching live streamers, you’re sending
virtual gifts, virtual money, in-game currencies. This is stuff that we see younger generations
in China actually spending a lot more money on. So while maybe the GDP growth hasn’t been
there in the way that we’ve expected it to, or the international scene has expected it to,
there’s still a lot of growth happening internally. Lewis: It’s probably one of the more difficult
things for people to wrap their heads around as they are looking at what
companies will win in that marketplace. The digital gifts culture is a lot different. It’s much bigger there.
Mann: It’s entirely different. Lewis: Many of the big businesses are these
digital businesses, these social media companies like the Tencents of the world,
that are connecting people. And they have unparalleled access to their communities.
I know you follow a lot of these businesses, Emily. It’s hard to equate what we know here as Facebook
to a Tencent because it’s not just Facebook, in the sense of social media. It’s so
many other things dropped into that app. Flippen: When you talk about
Tencent, you’re talking about WeChat. When people think about Tencent, they think
about it being the largest gaming company, largest entertainment company. But the real power of Tencent is the
ability that they have to centralize eyes. You see that with big companies here in the
U.S. Facebook and Google, we see them having antitrust suits simply because they are the
people that centralize users, centralize clicks. In China, that all comes down to WeChat. That’s because you can do so many different
things that you can do on WeChat that you could never dream of
doing on apps here in the U.S. The idea that innovation has somehow stopped
just because GDP growth has slowed down can’t be further from the truth. Think about, the most downloaded app
in the world right now, I believe it’s TikTok. People in the U.S. may
not realize, that’s a Chinese company. It was launched in China far before
it was launched in the United States. The fact is, that’s a completely different
app, has a completely different structure than anything we’ve
seen here in the United States. And it was a Chinese
company that launched it. Mann: TikTok is short form videos. In the same way that you
would consume Twitter, very short form. Lewis: You can think
about it kind of like a Vine. Mann: Very similar.
Lewis: Short form video content. Mann: It’s Chinese Vine.
Lewis: Buy highly viral elements. Flippen: Exactly.
And it’s not just that. We see that happening
with e-commerce business models too. A popular company, it’s been on
a total tear recently, is Pinduoduo, ticker PDD. This is an e-commerce player,
the second largest e-commerce company in China. It’s centralized, essentially,
e-commerce through group purchasing. You get up together with people all across
the country, and you get the power, 1,000 people want to purchase this, you get at a
lower price than just one person purchasing it. We don’t have that in the United States. The idea that just because economic growth
maybe isn’t what it was 10 or 20 years ago, that somehow innovation and growth has stopped
in the country, couldn’t be further from the truth. Mann: It’s a really
interesting way to think about it. When you think about
growth, there’s two types of growth. You can go on a company
by company basis. You can have really inefficient growth.
You can have growth for growth’s sake. In some ways, China did that
for a bunch of years. You would go to Shenzhen, just north of
Hong Kong, you’d see new factories being built all the time, but the factory that had been
built a couple of years ago was still sitting empty. Maybe it was not the right time, maybe it
had been occupied and then they left. What you’re seeing in China now is in some
ways some efficiency gains that come at the expense of top line growth. Growth for growth’s sake is going to
end up overheating their financial system. Efficient return on invested capital driven
growth, even if it’s a lower top line number, will be better for China.
Lewis: We mentioned slowing growth a little bit. We do need to state the fact
— GDP growth is still 6% or 7%. We’re not down here some
anemic growth, depending on the numbers. Mann: Yeah. People talk
about China’s slowing growth story. Like, are you kidding? Our President would chew
his right arm off to get a 6% growth. As I said at the top, what is
taking place in China is so impressive. There isn’t something that you can compare
it to in history, the amount of economic value that’s been created. Lewis: I think what’s confusing for people,
though, is it seems like a lot of the big macro theses that people have been banking
on when they’ve been buying Chinese stocks have held. Purchasing power is going up.
We’re still seeing GDP growth, which is awesome. And yet, the Shanghai Composite Index, down
40%, something like that, over the last five years. A lot of major Chinese companies
are well off of their all-time highs. So, even with what seemed like really awesome
tailwinds, some of these businesses are still struggling. Flippen: Yeah. It’s funny, it’s almost
a catch 22 if you’re a Chinese company. You can choose to list
on the Shanghai Exchange. You can choose the list
in your home country. But the regulatory requirements you
have for that, and the amount of control that the Chinese Communist Party has over that,
incentivizes you to list elsewhere. But you come, list in the United States, and
because American investors right now are so trepidatious — to use it lightly — about
Chinese companies, it’s much harder to prove yourself as a Chinese company in the
American markets, especially given the contentious history that Chinese companies have
had being listed in the U.S. market. It’s a hard time right now to be
a legitimate growing Chinese business. You’re faced with listing on an exchange
that has historically been beaten down. Not a great place to put your money. Vs., in the U.S., where we’re seeing even
the big names now — Baidu, Tencent, Alibaba — being hammered. Mann: You to keep in mind that the Shanghai stock
market is, as much as anything else, a political tool. You can’t look at that stock market and say that
it’s the same thing as the New York Stock Exchange. It’s not the same thing as the S&P 500. Both the banking system and the stock markets
in China are, in some ways, extensions of the political system.
That’s just reality. When the market started dropping several
years ago, the government just stopped it, like, “No more trading,” and put
a bunch of money into backed companies. So, yes, the Shanghai Exchange
is down substantially. I think a lot of that is driven by the fact that
people are aware of the fact that it’s a little bit… I don’t want to call it a rigged game on
live video, but it is rigged in a way that the U.S. stock market,
and Western stock markets, are not. Lewis: Political interests might be the perfect
segue for us to talk a little bit about what’s been going on with the
trade war with the United States. Mann: Haven’t heard
anything about it. Wait, what? Lewis: And, the back and forth that we’re
seeing with this tit for tat on tariffs. Bill, I know you’ve
been following the story quite a bit. What are you making of it at this point?
Mann: It’s really bad news for China. It’s not so bad news for the U.S. Chinese
imports into the U.S. account for about 3% of all GDP in the U.S. It’s a big amount, 23% of our imports,
but only about 3% of economic activity. The U.S. will be fine regardless of the
outcome. Like, it might not be comfortable. We hear every day, companies are
saying that they’re feeling the pinch. But ultimately, this is much bigger stakes
for China than it is for the United States. President Trump has really focused on this.
This is a bread and butter issue for him. He’s got an incredibly strong negotiator in
Robert Lighthizer as the U.S. trade rep who is going after Chinese companies and Chinese
interests in a way that’s really uncomfortable for China. You’re starting to see U.S. businesses move
outside of China and come to alternate sources for a lot of the same goods.
It’s bad for China the longer this goes on. Lewis: We’re going to be taking questions
from the audience watching live in a little bit. I’m going to anticipate,
I think, one of those questions. With the trade war,
we see all these scary headlines. We see the volatility
in the market start acting up. Emily, when you look at all of that, how are
you thinking about that from a personal investing perspective, and the kind of stuff we want to remind
our members of when they see this type of stuff? Mann: Panic!
Lewis: No. Flippen: [laughs] Put everything in bonds.
No, I’m just kidding. Obviously, don’t do that. Mann: No.
Flippen: I will say, if you do choose to buy
Chinese companies — and Bill and I are both still comfortable with
buying Chinese companies — you have to understand the
macro environment that we’re in. We’d be remiss to not talk about what’s
happening in Hong Kong right now, for instance. Looking at it from Trump’s perspective is
one thing, but looking at it from China’s perspective is a totally different thing.
Mann: Much more important. Flippen: Exactly. So, you wonder why we haven’t
come to some agreement with the trade war. You can look at what’s happening in Hong Kong,
and how important is for China to come up as a strong power. We see people
in Hong Kong waving American flags. If you think that’s going to be conducive
to solving a trade war anytime soon, you’d probably be wrong. If you do choose to buy Chinese companies
— and like I said, we’re invested in Chinese companies. It’s not something that I think
long-term is going to be an issue. But, I do you think it’s probably going to
take a change of administration either on the U.S. side, more likely — very unlikely on
the Chinese side — for some solution to come to a head. With that in mind, if you do choose to invest
in Chinese companies, be aware of that. Be aware of the fact that because of these
macro events, these companies don’t tend to trade as logically as you might
expect U.S. based companies to. We’ve seen lots of great Chinese companies
post pretty amazing numbers over the past few quarters and get absolutely hammered.
You should expect that volatility. You should come in expecting to lose upwards
of 40% or 50% of your investment because of a tweet. Just understand that you’re in it for the long term,
and you’re buying and holding that investment. Lewis: Before we hopped into the studio,
I wanted to have both of you guys prepare a stock that you think people should
have on their radar as a way to play China. Obviously, there’s still growth ahead.
With all the caveats that you mentioned before. Bill, you have one that is probably
a fairly familiar name to a lot of people. Mann: Yes. A lot of people
probably don’t know that Yum! Brands completely spun out its China
operations few years ago [into Yum China]. About 9,000 stores between Taco Bell,
really KFC helping out here, Pizza Hut, and they also have
some Chinese brands. They have a coffee brand and
a hot-pot brand. Yes, that’s right. [Yum China] opened hot-pot restaurants in China.
They’ve done well. It’s called Little Sheep. Fabulously run company. One of the things that I’m always really nervous
about with Chinese companies is the verification of accounting is so hard to do, in some ways
because the government actually puts up impediments that prevents outside accounting
firms from doing a thorough accounting job. Yum China is under the
same umbrella that Yum! Brands is under. It’s a fantastic growth story.
They’ve really got it right in China. I think that’s a rather conservative
way to play an excellent market. Lewis: It sounds to me like that’s a way to
play China while having some of the creature comforts of being a U.S. investor.
Mann: Yeah, which is something that I really seek out. One of the things that I’m mindful of is,
during the last huge Chinese bull market, here in the U.S., some of the reasons that
a lot of people’s money disappeared was because the government made it really
hard for us to do verification. You have to keep in mind, when you’re talking
about Chinese equities in general, that you aren’t necessarily afforded the same investor
protections that you are in almost any other country in the world. That’s just reality. Now, Emily said earlier, we still both
are invested in Chinese companies. But, taking huge risks in Chinese companies,
you’re putting a little more at risk than you think. Lewis: For folks that are interested in a
maybe purely Chinese name, not something that’s been ported over to the Chinese markets,
Emily, you have a stock for us, as well. Flippen: I do. To cataract all of Bill’s totally logical, totally
+sane explanations, I’m going to risk it for the biscuit. If you are looking to risk it for the biscuit
in China, I have a great company. It’s a company that actually works with a
lot of American companies, so I guess it has a little bit of creature comfort in that regard.
The company name is Baozun, ticker BZUN. Baozun is an e-commerce aggregator in China.
It’s often referred to as the Shopify of China. Mann: Not quite right.
Flippen: It’s not quite right. And it’s not quite
appreciated like Shopify is, either. But it does do a lot of similar actions,
in the sense that it organizes and distributes companies’ e-commerce
presences in China. When you think about being an American brand,
or being a foreign brand coming to the Chinese market, trying to advertise, trying to get
consumers there is totally different than the way that you do it here in the U.S. Baozun
does a great job in centralizing their presence, attracting customers. They always
post great Singles’ Day numbers. Coming up into November,
definitely keep an eye out for Singles’ Day. That’s 11/11 in case anybody was wondering.
Mann: The largest shopping day on Earth. Flippen: Of course.
So, Baozun always posts great numbers. They do a lot of gross
merchandise value during that day. Even amidst this really big trade war, a trade
war that’s gone on a lot longer than investors and consumers have
expected, Baozun has continued to grow. It’s really impressive, because a lot of their
growth is attributable to international brands wanting to reach to the Chinese market. I like it because it’s a company that’s performed
really well, beaten expectations, raised expectations, even amidst slowing economic growth
and an increasingly hostile trading war. It’s a great company.
It’s one of my larger personal holdings, as well. Mann: One of the nice things about Baozun is, we as
investors have two insurance policies with Baozun. One is, they are doing business
with really large multinational brands. The multinational brands have no interest
involving themselves with any type of partner that is going to embarrass them. The other thing is that we’re not counting
on these international brands to go in China and succeed themselves.
Baozun is, in some ways, a protected company. I own it personally. It’s in the Global Partners
portfolio. It’s a great company. It really is. Lewis: We’re going to switch gears and do
live Q&A with the folks that are watching this broadcast while we’re live. If you have any questions,
make sure you’re dropping it into the chat box. I am going to kick us off, though, with questions
that came via comments on some of our other YouTube videos.
Mann: Oh, that’s exciting! Lewis: Right?
Nice little plug there. They’re related, I swear. The first question. “I’m seeing a lot of foreign
stocks that you guys talk about are ADRs. What exactly is an ADR?
How does that differ from a normal stock?” Mann: It’s a great question!
Functionally, they differ very little. You can buy an ADR or you can buy a U.S. stock,
and it’s exactly the same thing functionally. Technically, what an ADR is, is a secondary
listing for a company that has their primary listing somewhere else. Most Chinese companies that trade in the U.S.
are not at ADRs, they are direct listed here because they don’t have a listing in China. So, really, the only differences with ADRs
is, there’s a small fee involved that goes to usually Bank of New York.
Good business for them. And sometimes you don’t
get the same level of voting rights. That’s literally the difference. Flippen: To Bill’s point, if you use an acronym,
we should probably say what it means. Mann: Thank you! I agree!
American depository receipts. There are other types. There’s GDRs, which is
Great Britain depository receipts. It’s not just in the U.S., but with the U.S.
being the largest market in the world, foreign companies that would like to raise
capital here have to do so with an ADR listing. Lewis: We’re going to switch over
to some of the ones from the live audience. Our first question there. Todd asks,
“Which Chinese stocks should we sell short?” What’s maybe brining this question on is,
we talk about some of the big declines that some of these companies have experienced recently,
maybe there is a certain interest in doing that. Personally, I tend to stay away from shorting anything.
The risk/ reward there is a little lopsided. It’s something that I don’t
quite have the stomach for. I know that’s the guidance
that we tend to give newer investors. Anything to add there? Mann: I wouldn’t short a single Chinese
company unless you had specific knowledge that it was a fraud. And it has to be specific knowledge.
You’re talking about a growth market. Anytime you’ve got a company that is within
a growth market, even if the company stinks, they still have a pretty good tailwind. Chinese companies are going to fail; American
companies are going to fail; regardless of the economy. But the companies that are Chinese that are
listed on the U.S. stock exchanges are not, generally speaking, fly by night operations. Lewis: Yeah. One of the things that sometimes
gets lost in the shorting conversation is, you’re betting against the overall
movements of the market. Flippen: In a specific time period as well.
Lewis: Right. You don’t want to be bound by time. Time is your friend. Go along with time.
Don’t worry about being right at a specific period of time. Mann: My big preference for shorting is,
look for large companies that have terminal issues. I would not spend too much time. If you’re really interested in figuring out
that a company is a fraud, I guarantee you some companies in China are
defrauding American investors, right now. But even just because you figure it out doesn’t
mean you’re going to get away with it. Lewis: Yeah. You have to be right,
and the market has to realize that you’re right. Flippen: You have to be right, you have to
be right at the right time, the market has to realize that you’re right
in that specific time frame. And, most of these Chinese companies that
you’d want to short, their float’s very small, and any short position that you take would
be a very expensive short position to take, as well. You’re paying a lot to open up
that position. It’s not a good idea. Lewis: That’s a long way of saying, there’s
a lot of things working against you if you want to short Chinese stocks. We have a couple of people asking,
“If there is a recession,” I guess this question is geared towards a more global recession,
“who would take a bigger hit? The U.S. or China? Perhaps both around the same time?” It seems to me like the answer may be both
because we’re at a point where things are so interconnected.
I’d love to get your take on this one. Mann: I love the fact that people don’t realize
that the global economy is already in a recession. I saw this headline not that long ago. The U.S.
is the least worst economy in the world right now. We are doing “eh,” but nobody else is.
It depends on what type of recession it is. If it’s a banking recession, the U.S. is in
for it, simply because the Chinese banks are somewhat isolated from the global economy. If it’s a manufacturing recession,
or a spending recession, China’s in for it. Flippen: Here’s the thing. Because China does have a centralized economy,
there’s a lot that the Chinese Communist Party and their leadership can do to stimulate the
economy that we don’t here in the U.S. Now, I’m not saying that’s
a good thing over the long term. Mann: It’s just an “is.”
Flippen: It is an “is.” So, they have a lot more levers they can pull to re-stimulate the economy
than we do here in the United States. That being said, recessions don’t tend to
happen on a global scale unless they come out of the United States. I do think that if we see something like we
did in 2008, 2009, then it’s probably going to hurt the U.S. stronger
than it hurts countries like China. Mann: It’s true that right now, straight by
the numbers, the United States has the most expensive stock market in the world. Just on a price to sales basis,
price to earnings basis, book value. We have the most expensive stock market
in the world. There are reasons for this. It is the most trusted
stock market in the world. But you do have to keep in mind
that whenever something is expensive, it also comes with high expectations. It really could be that U.S. stocks could
get whipsawed even worse than the economy actually does, in a recession. Lewis: Emily, your point about political control
winds up touching on something that a couple of different viewers are asking. It’s getting at the idea that, the Chinese
government has plenty of control over what happens in China. How do you weigh that when you are looking
at some of the big stalwart businesses? It seems so difficult to separate China the
government from China the very strong, almost state-sponsored
company that exists there. Flippen: You can’t separate them.
That’s the blunt truth of it. Most of these companies, especially the larger ones,
do bow to some level of Chinese government influence. What I look for when I’m looking to make a
Chinese investment, if I can accept the fact that there’s always going to be that influence
— for a lot of investors, just trying to accept that fact is too much. That’s fine,
you shouldn’t be adding Chinese exposure. But what I do is, I look at the Chinese Five-Year Plan,
what the government hopes to accomplish over the next five years, over the next 10 years,
and I make sure that company plays in that somehow. We don’t see that the Chinese government is going
to significantly hurt companies like Baidu or Tencent. Now, they could change gaming regulations,
which could momentarily hurt Tencent, but Tencent not going anywhere because it’s such
a strategic company to the Chinese Five-Year Plan. The same is true for
China Mobile, the rollout of 5G in China. That’s something that’s
extremely important to the government. So, when I look for companies in China,
I look to make sure that they’re not going against what the government has
already said they hope to achieve. Mann: Do you know about the
social capital ratings in China? Flippen: Ohhh, yep!
Mann: It’s being rolled out, it’s pretty much out. Basically, every person in China has basically
a rating of how trustworthy they are. Flippen: Well, they’re hoping to get there. Mann: They’re not all the
way there, but it’s being rolled out. And there are people
who are now being rated. And if you have a low trustworthiness rating,
you might not be able to get train tickets, you might not be able to move outside of your
region, you should assume you’re being followed. These things exist. Well, what a lot of people don’t know is,
there’s also the same rating system that’s being rolled out for corporations. One of the reasons the trade war is happening
now is, we are 100% sure that there’s been an amazing amount of theft of IP
from China over the last three decades. A lot of foreign companies are really nervous
about this, because in order to get a higher social capital rating, they have to turn over
a lot of IP and a lot of internal documents to the Chinese government. I’m not sure that it’s Chinese companies that
the Chinese government is looking to impact in a negative way. It’s foreign ones. Some foreign companies are saying,
“We’re just not going to play in China anymore.” Lewis: Emily, you mentioned the regulations
that are affecting some of the major social media and gaming companies in China. That’s actually one of the very clear similarities
between the U.S. major tech companies and some of the major
tech companies in China. It seems like both of them have gotten
to the point, particularly in the digital ad space, where people have started to question
whether they’re always doing the right thing. The reckoning is coming
for some of these businesses. Some of the pinch that these companies are
feeling now is the government reaching out and saying, “Maybe we need to be putting in
some regulations here to make sure that you guys aren’t just advertising anything.”
Flippen: That’s true. We saw a few years back with Baidu,
their advertisements actually caused the death of a young man in China who had clicked on an
advertisement for a medical company that was not a real medical company.
Mann: That’s not what killed him. He actually got the stuff, right?
Flippen: Yeah. Not just clicking on the ad directly. Mann: They haven’t
come out with murder ads. But, he bought from
a quackery, and it killed him. Flippen: Exactly. This pain is still
felt amongst the Chinese consumers. We saw recently the CEO of Baidu presenting
at an event, and somebody from the audience came up and poured water over his head.
It was quickly squashed by the Chinese media. The fact is, we see a lot of the same issues, especially
as it applies to advertising in data privacy in China. But the issues from a government
perspective are totally different. When the U.S. government’s looking at companies
like Facebook and Google, they’re almost looking at it from a, “Should we
break up this company? Should we cause the U.S.
market to be more free, more competition?” China doesn’t care
so much about competition. They care about retaining
control in their government. If Tencent plays well with them, they don’t
want to cause competition that could therefore potentially disrupt the power that
they have set up already with that company. Again, similar problems, but different
execution based off the government’s purpose. Mann: Jack Ma, the chairman of Alibaba,
came out two months ago, and he confirmed that he is a card-carrying member of the
Chinese Communist Party, and he has been forever. Flippen: It’s not
a particularly rare thing in China. Mann: It’s not, but I think it’s a little
bit of a cultural shock for Americans who think, “Oh, these are the capitalists.”
No. These are members of the governing body. They just happen to be in a capitalist pursuit.
But he’s very much a party member. I think if you were to be able to ask the CEOs
of all of these companies, it would be the same. Lewis: I think that’s going to do it
for this broadcast. We’ll stop things there. Thank you guys so much!
Mann: Was that a happy place to stop? I don’t know!
Lewis: I’ll leave that for the viewers to decide. Emily, Bill, thank you so much
hopping on this broadcast and joining me! Bill, we have an international
service you’re highly involved. For folks that are interested in
more international themed stuff — Mann: Global Partners. Thank you!
Lewis: Thank you to the folks that are watching live! We love having
interaction and the live Q&A! Like I mentioned, if you have questions we didn’t
touch on that are more basic investing questions, we have that investing starter
kit over at fool.com/start. It takes you from starting your emergency
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We love getting ideas for themes for future ones. Until next time, I’m Dylan Lewis.
Thanks for listening and Fool on!