What happened
Fears about investing in Chinese tech stocks reached a fever pitch Monday, as international megabank J.P. Morgan announced "double-downgrades" on three of the biggest names in China tech: Baidu (BIDU 0.98%), NetEase (NTES 1.02%), and Alibaba Group Holding Limited (BABA 2.92%).
As of noon ET, NetEase shares are down 7.2% from Friday's close, Baidu stock is off 7.5%, and Alibaba is leading the Chinese tech sector lower with a loss of 8.2%.
Image source: Getty Images.
So what
What's the problem with Chinese tech today? For one thing, there's the continuing risk that a whole lot of Chinese stocks -- even the big ones -- might have to delist from U.S. stock exchanges if China's government can't find a way to work with their U.S. counterparts to permit full and accurate auditing of Chinese companies' financial reports.
That was the biggest factor ailing Chinese stocks last week. But as J.P. Morgan explains in its note downgrading Alibaba, for example, Chinese tech stocks have problems specific to China -- beyond just the risk of delisting in the U.S. Currently, says the analyst, "risk management [has become] the most important consideration for global investors in relation to their China Internet investment strategy." And viewed in this light, "China Internet [stocks look] unattractive on a 6-12 month view with an unpredictable share price outlook, depending on the market perception of China's geopolitical risks, macro recovery and Internet regulation risk," as J.P. Morgan outlines in its note covered by StreetInsider.com.
Consequently, Baidu, NetEase, and Alibaba stocks are suffering from "negative fund flows" as international investors dump the stocks, notes TheFly.com. And the fact that J.P. Morgan now rates each stock underweight (i.e., sell) isn't going to help matters much.
Now what
Granted, there will come a point when this sell-off ends -- and when the end comes, J.P. Morgan believes investors will be able to look forward to "potential multi-baggers" among Chinese tech stocks. The question investors need to worry about, though, is from what price point those stocks will begin as they ascend to multibagger status.
Obviously, the cheaper a stock is to start with, the easier it is for that stock to double, triple, or more. And this makes valuing Chinese stocks of paramount importance. But currently, NetEase at 25 times earnings is the cheapest of the three tech names up above. Next comes Alibaba with a 28 times earnings valuation, followed by Baidu at 36.
Simply put, while not egregiously expensive, none of these stocks actually looks "cheap" based on current P/E ratios. Absent clear and compelling "valuation support," warns J.P. Morgan, "the sector-wide sell-off might continue."
