Most investors have found investing in Chinese stocks an almost impossible task today. Some deem the nation as "uninvestable." However, some mega investors have started to find value to be had in some of the country's stocks; guys like Ray Dalio and Michael Burry (the one who called the 2008 financial crisis) started buying into the more prominent blue-chip names in the technology sector as well as the consumer discretionary space.
While Dalio – in true macro investor fashion – decided to plunge into the broader iShares MSCI China ETF (NASDAQ: MCHI) to expose his fund to a comprehensive list of stocks in the region, Michael Burry initiated a more than $10 million position into more specific names. Split between Alibaba Group (NYSE: BABA) and JD.com (NASDAQ: JD), Burry is betting on a more significant comeback in the country's equities.
Stock picking in the middle of a broader index turnaround can pay off in a big way. That's why today, you can focus on the automotive stocks in China. Traders and analysts are specifically looking at XPeng (NYSE: XPEV) stock as a positive outlier that will likely amplify the effects of this coming bull run. More on why later, for now, focus on the big picture.
Here's the attraction
Capital held by the most prominent investors, hedge funds, and investment banks or asset managers like BlackRock (NYSE: BLK) typically rotate into the places where a more significant return is offered. That is so long as there is not an added level of financial risk coming from it (emphasis on financial).
Because these stocks don't represent increased financial risk, buying into them wasn't as bad as most of the market thought. Yes, there is more geopolitical risk in that tensions are high between China and the United States, but that doesn't take away from the fact that you can find some wonderful businesses at a discount.
Because the current spread between the yield offered by the CSI 300 index (China's version of the S&P 500) is up to 5.5% today, investors will eventually be unable to ignore the attraction, considering that China's ten-year bond yields sit at 2.5% today. A similar thing happened in the U.S. markets in 2020; here's what happened.
In 2020, the S&P 500 paid up to 2.5% in dividend yields (its highest since the financial crisis of 2008), all the while the U.S. ten-year yield paid below 1.0%. When stock yields go above bond yields, money tends to flow aggressively into stocks, chasing only one thing: growth.
Now that investors are willing to assume the risks involved in exposing themselves to the China growth story, it may be time for you to look at some of the best outliers within this great pivot. So, why, of all places, would you start looking into the automotive space in the region?
Stimulus is coming
The Chinese government has been pushing the support line higher for its financial markets to avoid a further sell-off. In its latest round of support, the government injected up to $278 billion into its economy, giving banks more flexibility in their reserve requirements.
Any other country and the stock market would have risen past multi-year highs on the news, which only reflects exaggerated pessimism dominating the region. But what does it all mean for XPeng? Easy financing and cheap money drive people into buying one thing as a status symbol: cars.
But what about the other guys in the market? Popular names like Nio (NYSE: NIO) and Li Auto (NASDAQ: LI) have a better track record of attracting retail investors. Well, the pros may be in high appetite for a change of scenery, where XPeng stands out.
While the automotive industry is expected to grow its earnings per share by an average rate of 12.5%, analysts believe that XPeng will see 56.0% growth in the next twelve months. Still, the market is telling you something that expresses its optimism over the other peers.
Starting with their price targets, a $18.7 consensus will reflect a 106.0% upside in the stock from where it trades today. When it comes to Nio and Li Auto, the way markets value the companies gives you all the evidence you need to justify the price targets in XPeng.
Keep in mind that analysts at Morgan Stanley (NYSE: MS) also upped their targets to $25.4 a share, which is a much bigger upside of 167.0%!
Because these are younger, fast-growing companies, you can't rely on the typical price-to-earnings ratios to get a sense of valuation but rather form your opinion on the price-to-sales ratios. XPeng trades at a 2.3x P/S multiple, above both Nio and Li.
Nio is roughly 40.0% discounted from XPeng in its 1.4x P/S multiple, and so is Li Auto in its 30.4% discount from the 1.6x P/S valuation it carries.
The saying "It must be expensive for a reason" stands true in this comparison, and now you can pinpoint what that reason could be: money is coming to the market fast, and XPeng is ripe for the taking.
