The "Magnificent Seven" is a group of tech stocks that delivered solid returns in 2023, propelling the S&P 500 index to greater heights.
But just because these giants outperformed in 2023 does not guarantee the same in 2024. For example, Tesla stock has had a tough time in 2024, down close to one-third from its 2023 high. So just buying this group of stocks and hoping for the momentum to continue is not a sure thing.
Fortunately, investors could consider other companies of similar business quality for their portfolio. Tencent Holdings Limited (TCEHY 2.19%) is one of these companies. Here's a closer look at why that's the case.
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Tencent owns a group of high-quality and diverse businesses
Founded as a small messaging service company (QQ), Tencent has become a conglomerate with business interests spanning multiple industries including social networking, gaming, entertainment, fintech, cloud computing, and more.
The core of Tencent's empire lies in WeChat, a social media networking and communication service that has evolved into a super app. With just a single app, Chinese citizens can communicate with their family and friends, carry out online payments, book online services, access public infrastructures like transportation, play online games, engage in e-commerce, and more.
In addition to the wide range of services, another element of WeChat's dominance is its 1.3 billion user base, giving it a considerable network effect advantage. As these users rely on WeChat for most of their communication, they must use the app frequently (and the majority use it daily). As long as these users keep returning, Tencent is in a prime position to monetize them via advertising and other value-added services discussed above.
Tencent's success is evident in its financials. Since its IPO in 2004, revenue and net profit have risen from 1.1 billion yuan and 447 million yuan in 2004 to 554.6 billion yuan and 115.6 billion yuan in 2022.
Besides its wholly owned and operated businesses, Tencent owns stakes in leading tech companies worldwide. For example, it holds more than 10% of leading e-commerce companies like Pinduoduo and Sea Ltd, giving it access to the massive growth opportunities of the e-commerce tailwind.
Tencent also owns (or used to hold) minority stakes in listed companies like Tesla, Snapchat, and Spotify, which also give the tech behemoth indirect access to the growth of these leading tech companies.
In other words, investing in Tencent's stock is similar to owning partial interests in a diversified group of high-quality businesses in China and beyond.
Investors are shying away from Tencent's stock
Tencent might have been the leading tech company in China, akin to the Magnificent Seven in the United States, but its valuation is nowhere near those of its peers. Tencent's stock trades at a price-to-earnings (P/E) ratio of 12.4. On the other hand, Magnificent Seven stocks Meta Platform and Alphabet trade at P/E ratios of 32.9 and 23.9, respectively.
Tencent's stock is even cheaper if we consider the 811 billion yuan ($113 billion) in investments in listed and unlisted investees. Removing these investments from Tencent's valuation would lead to a lower P/E ratio.
However, investors are pessimistic about Tencent's stock, and not without reason. On one level, investors have to deal with additional risks when investing in Chinese companies, which include political risks, low transparency, and cultural differences. For example, big tech companies like Tencent and Alibaba went through brutal regulatory crackdowns in recent years, one which many did not foresee in advance.
And with the ongoing (and worsening) geopolitical tension between the U.S. and China, most investors don't have the risk appetite to invest in Chinese companies, even though some are among the best globally.
However, for investors willing to accept these additional risks, Tencent's stock looks like a tremendous bargain at today's price point.
What does it mean for investors?
It's rare to find a company of Tencent's quality. But to have the opportunity to buy it at its current valuation is almost unheard of.
Still, buying Tencent's stock when the general investing public is shying away from it requires enormous courage and patience. And investors need to be comfortable with investing in Chinese companies.
But for those willing to accept the uncertainty of investing in Tencent, buying the stock today looks like a smart move.
