With Asia's biggest tech companies, Alibaba Group Holding (BABA) and Tencent Holdings (TCEHY) , having doubled and more this year, the question is whether we're in bubble territory. Are investors now chasing gains if they buy those companies, or buying into China's wired and mobile future?
Nomura (NMR) in September trimmed its positions in Alibaba and Tencent in its China equity portfolio, as part of a cut to its overall Internet exposure. That brought the combined weighting of the BATs - Baidu (BIDU) , Alibaba and Tencent - to 17% of the 29-stock model portfolio, down from what had risen to 23% thanks to the stock gains. Nomura's position is considerably underweight the 25% of the MSCI China index that's given over to Internet stocks.
Chinese Internet stocks are a little more expensive, at six times book per Nomura's calculations, than their U.S. counterparts (which were only slightly below that level). But they are posting better rates of growth, with an average 62% increase in income for the first half of the year, and better return on equity.
And that's the ball investors should keep watching. The revenues are growing fast for the Chinese tech giants, and they are also incredibly profitable.
China has become big enough as a market that it's no longer a tactical application to many global managers, and instead moving into the core portfolio. That means most managers will be buying the BAT stocks.
Managers had been underweight China, but the market as represented by the CSI 300 index is up 25% this year. Hong Kong's Hang Seng Index, where Tencent is the biggest component, is leading Asian indexes with a 35% gain in 2017.
Technology shares have driven the gains of the MSCI Asia Pacific Index, which has climbed to record highs that narrowly edge out its pre-crisis 2007 peak. It's up 33% in 2017.
The Asia technology sector is up by about two-thirds this year alone, with Chinese techs leading the charge alongside Samsung Electronics (SSNLF) , which has advanced an eye-popping 46% itself.
Tencent, up 117% in 2017, recently became the first Asian company to be worth more than $500 billion -- half a trillion dollars! -- in market capitalization. It's at $500.5 billion as of Monday's Hong Kong close. Alibaba, with its shares up an almost-identical 118% in 2017, won't be far behind, at $490 billion in market cap now. Baidu, up a "measly" 52% so far this year, is a minuscule $89 billion in market cap by comparison.
Although the huge advances in the BAT stocks leaves them in rarefied air, they appear to have plenty of oxygen with them to continue their climb into the stratosphere.
Standard & Poor's raised its rating on Tencent to A+ this April, anticipating revenue growth of 30 to 35% in its Weixin and WeChat chat apps. Those apps are for far more than chat, though -- they are used ubiquitously in China for everything from ordering food to hailing a cab, by almost one billion people (902 million daily active users as of the start of this month, and counting).
Tencent is also the major beneficiary of the move from computer games to mobile gaming. The maker of Honour of Kings, designed for multiplayer use on mobile phones and the highest-grossing game in the world, has made the most of the new medium and transitioned its own computer games onto smartphones.
S&P expects strong revenue growth in excess of 25% per year over the next several years for Tencent as a whole. Alibaba's pace of growth is similar.
Alibaba has the same A+ rating and stable outlook as Tencent. It is also likely to see overall revenue growth rise by 20% to 30% heading into 2018, perhaps faster if the company's nascent digital-media and cloud-computing businesses gain traction.
Both companies are extremely profitable. Tencent's EBITDA margin should run around 43% for the next two years, according to S&P, while Alibaba's margin is around 48%.
All of the BAT stocks are growing, not only organically but also through acquisition.
Tencent made its largest-ever acquisition last year, with an $8.6 billion deal to buy the Finnish mobile-game maker Supercell. Despite a high rate of mergers and investments, S&P judged the activity "moderate" relative to its cash flow, with the company generating around 100 billion yuan ($15 billion) per year in cash flow from operations.
Tencent is the biggest spender among the "Big Three," splashing out $62.5 billion in acquisitions since 2012, compared with $41.9 billion for Alibaba and $8 billion for Baidu.
Baidu, operator of China's most-popular search engine, has mainly spent within its sphere of current activity, spending $1.85 billion to buy 91 Wireless, the mobile-app store.
Mind you, Baidu still has its own range of "smart speakers" with artificial intelligence, the Raven H, and is working with King Long Motor on autonomous minibuses and self-driving cars with JAC Motors SH:600418, BAIC Motor (BCCMY) and Chery Automobile, three of China's biggest carmakers. It has its eye on creating an Android-like operating-system platform for smart gadgets: cars and consumer electronics. I'm waiting for those Chinese carmakers to make a big push overseas.
Tencent and Alibaba have been more-sprawling in their investment reach, Alibaba having in 2015 invested $4.6 billion for a 20% stake in the Chinese electronics retailer Suning Commerce Group SH:002024 in a move that bridges the clicks and bricks worlds. Suning has 1,600 stores in China. Alibaba has now invested around $2 billion for an 83% holding in Singapore-based e-commerce operator Lazada Group, the dominant online-retail site in Southeast Asia.
Tencent has translated Honour of Kings into Arena of Valor in the West. It, too, is expanding its reach well beyond China.
If you don't move toward the BAT Chinese tech stocks, in other words, they'll come to you.