4 Tough Lessons From My Worst Chinese Stock in 2019

I own several Chinese stocks, and many of them stumbled as the trade war escalated over the past year. However, my worst performing Chinese stock was SINA (SINA), the 21-year-old tech company which owns an older portal business and a controlling interest in the microblogging platform Weibo (WB 0.07%).

SINA's stock plunged about 35% this year as its revenue and earnings growth decelerated, while fears about the economic slowdown in China and tighter regulations for U.S.-listed Chinese stocks exacerbated the pain. Looking back, I realize that I ignored four bright red flags that were flying over SINA -- so it's time to review those mistakes and learn a few lessons.

Image source: Getty Images.

1. Chasing value instead of growth

SINA spun off Weibo in 2014, but still also owns a majority voting stake in the company. SINA also still generates most of its revenue from Weibo.

Two years ago, I swapped out my shares of Weibo for SINA. SINA generated slower growth (due to its older portal business), but it had much lower valuations than Weibo. Like many value-oriented investors, I thought SINA's lower valuation didn't properly reflect its stake in Weibo.

Unfortunately, investors were still willing to pay a premium for Weibo's streamlined growth, but they weren't willing to pay as much for SINA's sluggish portal business. As a result, Weibo fared slightly better with a 27% drop this year -- even though its forward P/E of 15 remains higher than SINA's forward P/E of 13.

In retrospect, I should have simply sold Weibo and avoided SINA. However, sticking with Weibo would have been slightly less painful, since growth stocks often trump value plays in bull markets.

2. Betting on an "old guard" tech company

SINA's portal websites were popular in the 2000s, but they struggled as Baidu (BIDU -0.43%) expanded its search ecosystem with new portal sites, Tencent (TCEHY -0.05%) corralled more users into its QQ and WeChat ecosystems, and disruptive challengers like ByteDance's Toutiao -- a news app that recommends stories based on a user's preferences and reading history -- entered the market.

SINA got left behind the tech curve, just as Yahoo was overwhelmed by Alphabet's Google in the U.S. Fortunately, Weibo survived that slowdown and became SINA's core growth engine.

However, SINA was still widely considered an "old guard" tech company, and investors flocked toward forward-thinking companies like Tencent and Alibaba instead. That's why SINA consistently traded at low valuations but failed to attract investors.

Image source: Getty Images.

3. Underestimating the downturn in China's ad market

I initially dismissed the trade war's impact on tech companies that generated most of their revenue from China, since they seemed well-insulated from tariffs.

However, I underestimated the trade war's overall impact on China's economy, which caused domestic companies to slash their advertising budgets. I also didn't realize that the Chinese government's crackdowns on the healthcare, gaming, and fintech markets would cause ad spending from those sectors to dry up.

But those headwinds hit hard, and ad spending on major platforms like Baidu and Tencent's WeChat slowed down. Only a few Gen Z-oriented ad players, like ByteDance and Bilibili, survived that downturn. Weibo and SINA are both much smaller players in China's ad market, so revenue growth at both companies hit a brick wall over the past year:

YOY = Year-over-year. Source: Quarterly reports.

4. Ignoring the stock's ownership structure

SINA went public in 2000, and its IPO introduced the VIE (variable interest entity) share structure as an easy way for Chinese companies to go public. China doesn't allow direct foreign investments in "sensitive" sectors like technology and education, so Chinese companies that want to go public overseas usually launch a holding company (the VIE) in a country like the Cayman Islands. The VIE, which is owned by Chinese citizens and holds shares of the Chinese company, then goes public overseas.

This structure is controversial because it shields the underlying company from U.S. auditors and doesn't give U.S. investors direct voting rights. SINA could also take the company private (as many other Chinese companies have done) and take it public again in China for a bigger profit. These issues -- along with calls from U.S. lawmakers for exchanges to delist Chinese stocks that use this structure -- are likely weighing down the stock.

The bottom line

These four lessons are probably cold comfort to investors who held onto SINA throughout its decline. However, spotting these four red flags could help you avoid similar losers in the future. I don't plan to sell my shares of SINA down here, but I'm planning to exit this stock in stages if it bottoms out.