Alibaba (BABA) and Baidu (BIDU) Offer a Tempting Risk/Reward Ratio at These Levels

Alibaba - maybefalse / Getty Images
Credit: maybefalse / Getty Images

Chinese internet stocks have taken a pounding. The big names are all down by at least fifty percent from their highs amid increased regulation, or at least increased rhetoric, from the country’s rulers, aimed at the rich and powerful providers of search and e-commerce services to the Chinese such as Alibaba and Baidu. Looking for a bottom on the drop has been a dangerous game so far, but there are reasons, both logical and technical, to believe that a disciplined play in one or both of those names is a risk worth taking at this point.  

Alibaba (BABA) got hit as early as last October, when it became increasingly clear that the Chinese Communist Party had taken a dislike to the company and its founder, Jack Ma, but it turned out that the antipathy went beyond Ma. Initially, the other big player in the market, Baidu (BIDU) benefitted from the increasingly hostile words aimed at Alibaba and the stock nearly tripled as BABA fell from its highs. By the end of February, however, it was clear that it wasn’t just Jack Ma that was upsetting the Party, and BIDU came back to earth with a bump.

2-Year/1-Day Chart for BABA

2-Year/1-Day Charts for BABA (top) and BIDU (below)

2-Year/1-Day Chart for BIDU

It seemed that traders and investors had forgotten that for all of its embrace of big business, China was still a totalitarian country, and that its markets were far from "free." More significantly, though, it seems that Ma had forgotten that, too. He had become increasingly vocal on subjects that went beyond his own business, and that visibility undoubtedly had an impact, but it was the growth of the financial side of the business and the attempted IPO of Ant Group that proved to be the tipping point. 

Remember, China’s leaders are well-versed in Marxist theory, so are all too aware of the relationship between money and power -- and they care about power. Allowing a private corporation to have control of finances, and to store massive amounts of data on the Chinese population, makes no sense for them, no matter how happy the people are with their new-found wealth. Some government muscle-flexing was inevitable, but keeping the people happy is also fundamental to the Party’s grip on power. Taking away the internet freedoms that the Chinese have become accustomed to would also be dangerous. Everything must be seen through the prism of holding onto power. Nothing else matters.

The logical outcome of all of that is that companies like Baidu and Alibaba would get a severe talking to and would be reminded not to overstep the boundaries but would then be allowed to get back to work. They may have their wings clipped a little in terms of their expansion plans, but they would still be allowed to do business. The question for potential investors then becomes, should you buy BIDU and BABA based on their existing business and expectations for organic growth rather than the prospect of takeovers and expansion?

The answer at current levels is yes, providing you stay disciplined.

Even if companies like Alibaba and Baidu are facing a more restrictive environment than they have become accustomed to in some ways, they are still money-making machines that exist in a huge, and still growing, market. Alibaba made just under $300 billion in the last twelve months, with Baidu earning over $53 billion. Both have massive amounts of free cash flow and serious cash hoards that are designed to offer a buffer against the always uncertain political and regulatory environment in which they operate. History suggests that is smart, but that normal service will be resumed once they have been reminded of their position in the system.

Long-term, therefore, these stocks are a buy, and now is a good time to make a careful, structured play to potentially benefit from that. Both have bounced off their lows recently. That doesn’t necessarily mean that the strong downward trend is broken, but the fact that these lows are right around the levels achieved before Covid and before the big jumps in the post-Covid market makes it likely. Those recent lows also create a logical level below which to set a stop-loss order, and that is an important part of the equation here. There are logical and historical reasons to believe that the Chinese government will act in a rational way (again, keeping in mind that everything must be seen through the prism of power), but that is never guaranteed in an opaque, one-party system of government.

At some point, BABA, BIDU, and other Chinese internet stocks will recover and the proximity to the levels before the post-covid surge make it more likely that the recovery will start soon. Buying around here, therefore, with stops just below recent lows that are set, and of course stuck to, look like a high risk/high reward trade that has a decent chance of success.

* Disclaimer: The author is putting his money where his mouth is and buying BABA and BIDU this morning, so will probably be long both stocks when you read this.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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