There are a lot of ways to make money on Wall Street. Most investors build their wealth by purchasing stakes in high-quality businesses and hanging on to those positions for long periods. It's the same strategy Berkshire Hathaway CEO Warren Buffett has used to generate a greater than 4,400,000% aggregate return on his company's Class A shares since the mid-1960s.
However, there are two sides to every trade on Wall Street.
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Short-sellers can make bank on Wall Street, too
Although it comes with the theoretical risk of unlimited losses and a maximum gain of 100%, short-selling is a strategy experienced investors will occasionally deploy. Short-sellers make money when the nominal price of a security declines in value.
Though the odds are definitely against short-sellers and bearish investors making boatloads of money on Wall Street, a few high-profile success stories stand out -- perhaps none more so than that of Michael Burry, the Chief Investment Officer of Scion Asset Management.
Burry's claim to fame, which is detailed in the 2015 film The Big Short, and the 2010 novel by Michael Lewis (The Big Short: Inside the Doomsday Machine), goes back to the financial crisis of 2007-2009. Scion purchased credit-default swaps (CDSs) on mortgage securities from a number of Wall Street investment banks, which allowed Burry to effectively bet against what he believed was a broken housing market. If the underlying assets Scion owned CDSs on were to default, Burry and his fund would be due a hefty payday.
When subprime borrowers began to default on their home loans, the dominoes began falling in Burry's favor, which ultimately resulted in an approximately $725 million windfall. It's this success that garners the "Big Short" investor quite a bit of attention from Wall Street professionals and everyday investors.
The two surprising stocks prominent short-seller Michael Burry is buying
Because Scion Asset Management had nearly $238 million in assets under management, as of the September-ended quarter, it's required to file Form 13F with the Securities and Exchange Commission. A 13F provides a snapshot of what Wall Street's brightest minds were buying and selling in the latest quarter.
Though most investors tend to focus on Burry's downside bets, it's what he purchased during the third quarter that should be turning heads.
Excluding options, Scion Asset Management purchased shares of nine stocks in the third quarter, none of which are more surprising than the 125,000 shares of JD.com (JD 6.12%) and 50,000 shares of Alibaba (BABA 0.59%) that were added. Alibaba and JD are China's respective No. 1 and No. 2 e-commerce companies by market share.
What makes these purchases so shocking is the added risk that often accompanies investing in China stocks. For instance, Chinese regulators cracked down on Alibaba in 2021 after an anti-monopoly probe found that it had abused its leading market position in the e-commerce space. Chinese regulators ultimately levied a $2.75 billion fine on the company.
Another example involves the U.S. passage of the Holding Foreign Companies Accountable Act (HFCAA) in 2020. The HFCAA allows U.S. regulators to delist China-based companies whose auditors fail to comply with U.S. accounting standards. There was a brief period of time last year when major China stocks were at risk of being booted off the major exchanges. Though the HFCAA is no longer a concern for Alibaba or JD, it's an example of the divide between U.S.-based and China-based stocks.
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Three reasons to be bullish on China's e-commerce juggernauts
To see Burry willing to take on the added risk of owning China stocks is a bit eye-opening. But there are some tangible reasons for this optimism.
To begin with, the Chinese economy is working its way back from a difficult three-year stretch. China's regulators implemented strict and unpredictable lockdowns during the height of the COVID-19 pandemic. Although the country's "zero-COVID" strategy was abandoned in December 2022, it's going to take time to work out supply chain kinks that have been pervasive for three years. Once these supply chain snafus are ironed out, China's economy has the potential to handily outpace U.S. economic growth. That would be positive news for the two largest online retailers.
A second reason Scion Asset Management may have piled into the dynamic duo of Alibaba and JD is their burgeoning ancillary segments. Through March, Alibaba claimed a whopping 34% of cloud infrastructure service spending in mainland China, according to estimates from tech analysis company Canalys. Meanwhile, JD Health and JD Logistics offer alternative ways for China's No. 2 e-commerce company to accelerate its organic growth rate.
However, the top selling point for "Big Short" investor Michael Burry might just be Alibaba's and JD's attractive valuations. Though China stocks are usually priced at a discount to reflect the added risks I described earlier, Alibaba and JD are currently trading near historically low earnings multiples since going public.
As of the closing bell on Nov. 24, 2023, shares of Alibaba could be purchased for less than 8 times forward-year earnings, while JD.com can be scooped up for less than 9 times Wall Street's forecast profit for the company in 2024.
While both companies offer an intriguing value proposition, JD is the one I'd personally side with. It's also the one I currently hold in my own portfolio. Whereas Alibaba primarily relies on third-party sellers within its online marketplace, JD is predominantly a direct-to-consumer (DTC) e-tailer. Being able to control the inventory and logistics of the DTC process should give JD the long-term edge in the margin department over Alibaba.
