The last year has been a great one to be an investor. Over the previous twelve months, the broader market has gained more than 10%, while tech stocks have increased more than 20%. As impressive as those gains might be, there is a group of internet giants that have vastly outperformed the market, enriching investors in the process.
While investors may be tempted to stick close to home, you might be surprised to learn that while stocks representing the U.S. online space have surged, those that operate in China have rocketed even higher. These three companies, search leader Baidu, Inc. (BIDU 0.55%), e-commerce giant Alibaba (BABA 0.31%), and social media titan Tencent (TCEHY -1.32%) may not be household names in the U.S., but they offer investors the opportunity to tap into the largest online population in the world.
The online industry in China is booming. Image source: Getty Images.
Data by YCharts.
China's online search leader and more
Baidu has been called the Google of China, but simply acknowledging its search dominance misses recent developments that could potentially present an even greater opportunity.
The company has arguably the largest artificial intelligence (AI) program in China and one of the most advanced in the world. Baidu poached Stanford University professor and noted AI expert Andrew Ng from Alphabet Inc.'s Google in 2014 where he headed the Google Brain project. Since then, Baidu has integrated AI across its vast operations, using it to improve everything from customer service to search relevance.
The company also has an ambitious self-driving car program titled Apollo that it recently open-sourced, gathering a roster of more than 50 partners, including such notable companies as Ford, NVIDIA, Microsoft, and Intel, with plans to begin small-scale mass production by 2020.
Baidu grew revenue by 12% year over year in 2016, and that growth is expected to accelerate to 27% for 2017. Massive investments in AI, autonomous driving, and streaming video have stifled earnings, with operating profit declining 14% in 2016. Still, as these investments begin to bear fruit, earnings growth could skyrocket.
E-commerce giant
Alibaba has taken e-commerce in China by storm, providing consumers with a marketplace where they can find virtually anything. In a model roughly comparable to that of eBay, the company doesn't sell its own products but provides the platform where buyers and sellers meet. That has been a very lucrative intersection between Chinese consumers and e-commerce. In its most recent fiscal year, the company saw revenue of $22.99 billion, which grew 56% year over year, generated by gross merchandise volumes of $547 billion, up 22% over the prior year. Income from operations grew an even faster 65% year over year, and monthly active users to the company's marketplace surpassed 507 million for the most recent quarter.
While e-commerce produced the bulk of Alibaba's revenue, several other areas were growing even more quickly. Digital media and entertainment grew to $2.1 billion, up 271% over the prior year. Cloud computing services increased to $968 million, up 121% over the prior year and has consistently seen triple digit year-over-year growth. While its cloud business is not yet profitable, Alibaba has become the sixth largest cloud services provider in the world.
Social media has a huge following in China. Image source: Getty Images.
Social media titan
You might not have heard of Tencent, but the company boasts the three most popular social media sites in China, so it's often compared to Facebook.
The largest, WeChat, has a foundation as a mobile messaging app, but its uses far exceed anything available in the U.S. market. It can be used to send text, voice, and photos, but it also has a curated news feed and ride hailing. WeChat Pay is an extensive mobile wallet for online and in-store payments that can also pay utility bills and send money to friends. WeChat recently surpassed 963 million monthly active users, while smaller SMS texting app QQ had 850 million, followed by traditional social media site Qzone with 606 million.
You might be surprised to learn then that Tencent is also the world's largest video game publisher, with more than $10 billion in game revenue last year. Honour of Kings was the world's top grossing game in the first quarter, generating $876 million in revenue, on the back of more than 50 million daily active users.
Tencent also has ownership stakes in many of the world's most popular games. The company purchased Clash of Clans developer Supercell, League of Legends creator Riot Games, and owns a 5% stake in Activision Blizzard, Inc., responsible for such titles as Overwatch, Call of Duty, and Skylanders. Tencent's investments have contributed to skyrocketing results. In 2016, Tencent produced revenue of $21.9 billion, up 48% year over year, while net income rose 42% to $5.97 billion.
There are risks
These stocks are not without risk, however. Earlier this month, the regulatory agency tasked with enforcing China's internet laws accused the internet giants of potentially running afoul of its recently enacted cybersecurity laws. The Cyberspace Administration of China issued a statement saying that it was investigating whether the companies' hosted content related to terrorism, pornography, and spreading fake rumors. The rules, which were introduced late last year and went into effect on June 1st, included requirements involving data storage and protection of user information, and included criminal penalties for violations.
Still, as an appropriately sized part of a diversified portfolio, these companies can help investors tap into the growing dominance of China's burgeoning internet industry.
