No. of Recommendations: 3
<<great contrarian thesis.personally, i wonder how many retail foreign investors have actually REALIZED gains from investing in individual chinese stocks the past ~2 decades. (given that the majority even underperform u.s. indices) regardless, simply from fund flows, the popularity of excluding china now from various funds\ETFs will start playing a role.>>
Chinese stocks, as well as European stocks, the last ten years have certainly realised poor capital gains, however this is not so much a function of earnings declining but rather the valuation multiples remaining low, and in the case of China the multiples falling considerably (the CAPE ratio in Shanghai fell from 70 in early 2008 to around 20 today). If you compare US stocks to European stocks over history, the CAPE ratios (earnings multiples) were highly aligned. Then something significant started to happen: Over the last decade the valuation multiples of US stocks compared to stocks elsewhere in the world suddenly increasingly diverged, and pretty spectacularly. As a result US investors have realised enormous increases in wealth since 2010, but not mostly from the rising earnings but rather from the rising valuations. As a largely US stock holder myself, I thank not skill but luck that this occurred up until the present.
If you look at the underlying earnings though, you see something different. The US stocks have not actually outperformed Chinese stocks to the manner we observe when just looking at the stock price. Indeed as you infer what matters is our realised return; however from here into the future what matters is the product of (1) the earnings growth and (2) the change in valuation. Having already seen a large positive change in valuation with US stocks, from here the only place to go is to either retain the high valuations, or realise lower valuations over the long-term. In the case of the Chinese firms, their valuation pressure is in another direction - they are unlikely to fall significantly (or the earnings yields would just become too seductive and more investors would step in) but they have an opportunity to rise.
<<being the rare non-fan of munger and his hypocrisy, it is an interesting reference for shred'm that he found alibaba to be his worst investment ever, and NOT on the basis of
- being in china
- the price he paid>>
This is a very good point and I discussed it emphatically at the Manlobbi Descent board when TMF was still around - the main problem Alibaba had was straight-forward business competition rather than regulation pressure; the latter being far more in the press but the former was what hit their core earnings.
Like Munger I was too optimistic about the durability of Alibaba's earnings against the other online retail competition. The IV10 formulae in 'Manlobbi's Descent' presents a mist of outcomes, with IV10 defined as using the lower estimates within this mist, but the mist I projected was not cast widely enough. The Steadfastness is intact but the IV10 estimate - which is a lower bound - was out. But Steadfastness itself - ie. the firm being around in 20 years with no risk of catastrophic loss or bankrupsy - is intact.
Getting the IV10 wrong in the past, though, does not relate to ever-present calculation as to what to do in the, well, in the present. At 7 times cash flow, you don't even need an organic increase in earnings to have an excellent return. Whether Alibaba use the huge cash flow to buy back stock, or merely use it to purchase new earnings streams, then in both cases at a per-share level it effects us very much.
To illustrate, consider the following though experiment. If you have a choice between (1) holding a firm (producing a lot of excess cash not needed for operations) at a high multiple for 20 years, and it finishing at the high multiple, or (2) holding the identical firm at a very low multiple for 20 years and it finishing at the low multiple, then which investment are you better with? In both cases you get to buy at the initial earnings multiple. Very few investors realise that they'd usually be a lot wealthy holding the second option. The reason is that the firm can buy back stock at lower prices and/or pay out a higher dividends relative to the initial investment. The change in multiples is the same, but the earnings per share grows more in the case of the stock remaining indefinitely at a low multiple whilst shunned.
- Manlobbi
