(Marketwatch) When the media and investors turn negative on stocks but the “smart money” is bullish, it’s a good time to think about buying.
That’s the case right now with the trifecta of Chinese internet giants: Alibaba, Baidu and Tencent. The same goes for the FAANGs in the U.S., say “smart money” investors.
Yes, the words “smart money” draw snickers from seasoned investors and cynics. After all, exactly what is the smart money, and how do you know?
It’s certainly not hedge funds. They’ve posted mediocre performance at best for the past year. And you can skip the geniuses who made tons of money calling the 2008 financial crisis. Most of them now look like one-trick ponies.
Instead, I like to use a simple test. Look for mutual-fund managers beating their competitors over the past three and five years. Sure, hot managers cool off, and outperformance comes and goes at mutual funds. But that’s a pretty long record of beating the market. It suggests a manager is more than just lucky.
Lately, several fund managers who pass this test have been pounding the table on Chinese internet names. The latest is Robert Stimpson, the portfolio manager of Rock Oak Core Growth. He beats his category of competing funds by 6.8 and 3.8 percentage points annualized over the past three and five years, respectively, according to Morningstar.
The Chinese FAANGs: A Google time machine
Chinese internet stocks look attractive because they’re down 30%-40% in the past few months on concerns about trade wars with China, and slowing growth in China.
But these might be temporary issues. And these companies still have the potential to post phenomenal growth, because they benefit from at least two big-picture “secular” growth trends, a quality Stimpson likes to put in his portfolio. They get a boost from 1) Rising incomes in China as more people join the middle class, and 2) Chinese consumers continuing to move online for shopping, banking, entertainment and socializing.
The upshot: Buying the megacap Chinese internet stocks Alibaba, Baidu and Tencent now is akin to buying Google (now known as Alphabet) in its early days. “They all have Google-type growth from 10 years ago,” says Stimpson. “If you could buy the Google of 10 years ago, today, I think you would. We like stocks that are down for short-term reasons that don’t impact the long-term thesis. These are three stocks I would bang the table on right here.”
• Alibaba is the e-commerce giant behind the popular online marketplaces Taobao and Tmall. It provides online payment services via Alipay, and cloud services. All of this makes it similar to Amazon.com. Alibaba posted 61% second-quarter sales growth.
• Baidu is China’s largest search engine. It reported 32% second-quarter revenue growth. Part of that strength came from excellent performance at iQiyi, Baidu’s streaming video business which is similar to Netflix.
• Tencent gives you exposure to online videogames, the social-networking platform WeChat, and the second-largest mobile payment platform in China, after Alibaba’s Alipay. All of these are huge growth areas in China. Tencent stock is weak in part because sales growth recently declined to 30% due to a slowdown in new game-title launches. But the company will probably make up for that next year.
All three companies have wide economic moats. This supports the case that they will bounce back. They also benefit from strong secular trends that will drive above-average earnings growth and allow for price earnings multiple expansion, says Stimpson.
These names look like simple buy-and-hold investments, since that is Stimpson’s style. His portfolio has a relatively low 31% annual turnover, according to Morningstar. In China, Stimpson also likes NetEase, a Tencent competitor in Chinese online gaming.
Buy the FAANGs
Tech continues to be Stimpson’s largest sector position. He likes this group in part because it offers a good combination of offense and defense, in the form of decent growth and solid cash flow. So he thinks tech and the FAANG names Facebook, Apple, Amazon.com, Netflix and Google are buyable in the current weakness.
“I don’t think this decline is the start of a recession or a sign that the economy is in trouble,” he said during the thick of the selling late last week. Instead, the selloff was a reaction to rising interest rates, stretched valuations, and fears about trade issues and Italy’s future in Europe. “This feels like a natural and normal correction rather than an indication that trouble is brewing on the horizon,” he says. “We are many quarters away from a time in which higher interest rates could inflict any damage on the economy.”
Avoid the hype
Stimpson attributes his outperformance in part to his policy of avoiding “hype” because it is a dangerous characteristic to have in a stock portfolio. Names to avoid on this basis include Tesla and cannabis stocks like Tilray in his view.
Of course, one investor’s “hype” is another investor’s bull case. So how does he spot it? A high valuation is the first sign. Next, hyped stocks have a big and vocal fan base. He also gets turned off by overly promotional management teams as well as companies that have constantly evolving stories.
One hyped sector he has ventured into is software as a service (SaaS) where companies rent access to software services as opposed to selling licenses. Here he favors Salesforce.com. “We like the SaaS model, but we find a lot of the companies in the space are highly valued without the track record to back it up. Salesforce is the exception,” says Stimpson. “They were the pioneer in the space and they outperform.”
Another way to avoid getting seduced by an overly promotional C-suite team — or any managers for that matter — is to simply avoid talking with them altogether. In a business where many investors crave private time with top managers in the hopes of getting an “edge” by reading body language or receiving nuggets of useful non-public information, Stimpson simply eschews all such meetings. Instead, he hears what managers have to say at conferences or in earnings calls.
“Building personal relationships with the companies you own leads to a bias in your investing process,” he says. “We spend a lot of time making sure we aren’t creating unintended biases in the portfolio. We want to remain independent.”
