Don’t Believe Everything You Read About Investing In China

In their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Don’t Believe Everything You Read About Investing In China. Here’s an excerpt from the episode:

Tobias: What about China stocks? They’ve been absolutely destroyed since that change in the regulatory regime. Have you followed that closely enough? Do you know what’s going on there?

Jake: I’ll defer to your wisdom.

Bill: I don’t know. All I want to do is make smartass comments like “China, China, China.”

[laughs]

Bill: No, I don’t know.

Tobias: You need a button.

Bill: No. Yeah, I do. That’s exactly what I need. Hey, Jake, if you can turn your volume up, I have noticed it’s a little quiet too. Somebody just said that. Baba is going to be really interesting to watch, because it’s basically the Munger rights, and everyone that’s followed them into it, and it’s going to be fun to watch how that all plays out. Gun to my head, I’d be long them. I really would.

Tobias: Yeah, I think Baba is cheap. Not cheap, I think that if you look at Baba over the last five years, this is the best opportunity, if he had to buy it five something years in terms of– I think it’s where it was five years ago, and on a valuation basis, it’s considerably cheaper.

Bill: Everybody’s just going to say to you, “How do you say it’s cheap? You can’t trust the numbers. You can’t trust China. They don’t value property rights.” That’s what people are going to say back to you, right?

Tobias: I understand, but I’m going to get to that in a moment. I was just saying that the business to me, the company to me looks cheap given that the rate at which it’s growing, the scale that it’s got to, the businesses that it’s got in there, the returns on equity that’s generating, if you can trust those numbers, it looks pretty impressive. The wrinkle to it is just you’ve got to get comfortable with the political atmosphere there. I don’t know, how you can– [crosstalk]

Bill: [crosstalk] 10 cents. Just from a high level, I’d rather have 10 cents business in Alibaba’s.

Tobias: I’d be more inclined to take a basket approach and buy a few of those things, but you’re either going to be– It’s so beaten up that on a valuation basis, it makes complete sense. The question is, does it fall apart for political reasons? I don’t know. I think you’re almost getting the odds to take the bet here, aren’t you?

Bill: I don’t know. Bears smarter than me say, “Don’t do it,” but my body says it probably makes sense. Because-

Tobias: [laughs]

Bill: – I think you probably —

Tobias: What part of your body?

Bill: All of it. The parts that matter. I don’t own it, because I don’t know it very well, but I do think that a basket tech approach on Chinese tech over the next 10 years does pretty damn well. It’s exactly the type of thing that I tend to look for. But I don’t know. Maybe they’re all frauds and the Chinese government fucks everybody.

Tobias: I don’t think they’re frauds.

Bill: Yeah, there’s some people that have said that have been wrong for a long time.

Jake: I feel a lot of the conversations are very reductionist thinking and then there’s much more nuance to all of this and it’s more complicated. I think painting in broad strokes like you see most of the conversations, I don’t think it’s very helpful, actually. So, I think transitioning any society from agrarian to the modern world is going to be messy. There’s going to be a lot of omelets made and eggs broken. It’s a lot like the US, if you looked at us from 1800 to 1900 which might be somewhat of a comparable, overlapping timeframe. I don’t know. I think they’re much more compressed now but [crosstalk] we have property rights issues, we had–

Bill: Do you mean to tell me that if somebody had said they actually have slaves, it’s uninvestable, that it would have been a bad decision not to buy US stocks at that time?

Jake: I just mean that the process of organizing an economy can be very messy and take a long time to really for us to all agree to the stories that this is how we’re going to operate going forward, which creates this web of trust, it can take a lot of time. It can be messy to get there, and maybe China is getting there faster in some ways, and maybe, they’re not going exactly the same place the US ended up. I don’t know, but I think there’s a lot more to this, and it’s much more multifaceted than just purely \can’t trust Chinese government, fraud at these companies, or Chinese government whacking tech companies. I don’t know.

When you think about the US, if you have stayed up on it, which I think most citizens have largely or at least the people probably listening to this, they would say, “Wow, the news headlines are so dumbed down, and so one sided,” and don’t really show any nuance about the situations that you know something about. I think the same thing is happening there as well, where there’s a lot more nuanced happening, and you get a headline, it’s like, “Oh,–” you would just make it this blanket kind of statement, and then I think you lose touch with reality a little bit when you do that. Just like if you were to only read the headlines of the newspapers here, I think you might be a little divorced from reality.

Murray Gell-Mann

Tobias: What’s the Michael Crichton line where he says, “You read the newspaper and they get the cause and effect inverted, like wet streets cause rain” is his example of it, I think, and then, what’s the name for it? I want to say Dunning–Kruger, but that’s not right.

Bill: I can’t help you.

Jake: Ah, Murray Gell-Mann, I think it’s the–

Tobias: That’s it. Yes.

Bill: He’s smart. He’s smart.

[laughter]

Jake: Yeah, Murray Gell-Mann– [crosstalk]

Bill: I’m done with that. That’s the last one.

Jake: I like them. I think they’re fun.

Bill: [laughs]

Tobias: I like JT’s take. We’ve talked about this a little bit before too. So, I knew where he was going to go with it, but one of the problems with investing is that all the nuance and so on gets to this point where ultimately you get to decide whether you buy it or not. So, it’s not particularly nuanced. So yes, you can size it differently. You just decide.

That’s probably the answer. Just take a little bit. But I do think that if the numbers are real, I don’t know what they’re not– there’s some red flags in it. There’s lots of websites that you can go to that do a pretty good job of picking apart Baba. But if you can trust those numbers, then it’s a spectacular company. There are analogs for it in the West as well. So, that it’s not entirely impossible of what they’re doing isn’t real. I think I’m leaning more towards it being a reasonably accurate reflection of what’s going on in that business, and then the question is, it’s a regulatory risk question. You’ve got regulatory risk everywhere in the world, you got regulatory risk in the States.

Jake: Yeah, you have economic reality and accounting numbers that often diverge in any system. The measurement can be just off. We’re just using conventions to try to approximate reality. Now, how accurate it is or not is a nuanced question which if you– Eventually, there’s a price where I think you’re compensated for the potential risk, no matter what it is.

Tobias: Yeah.

Bill: To be fair, I do think like the documentary, The China Hustle, or whatever, that’s worth somebody watching. There were a lot of actual true frauds, but the probability that Tencent is a fraud, I think when you talk to anybody that’s been over there and talks about how often WeChat is used and how it’s a super app, and then you think about what the economics of apps here are, I don’t know that it’s a fraud. It may not be quite as profitable as people think nut to Toby’s point, you’re not quite painting the rosiest outlook for it either.

Tobias: Right.

Bill: But I don’t know. It may not work, I’m sure if it doesn’t, the people that are bearish right now will be too certain that they were right, and if it does work, they’ll add it back and say, “Well, it’s a fraud for the next five years.”

Jake: I would say that, if we’re going to be counting macro concerns, and trends, and things like that, just as much in the positive column for China is 400ish million people live in cities today that resemble a western lifestyle. There’s another billionish behind them that may be coming and want to do something similar. That’s a pretty big ass tailwind potentially for an economy. You could almost say that the regulatory risks and all these other fraud things could be theoretically macrobalanced out a little bit with just demographics.

Bill: Jeff Nolan is saying that we’re being blasé about the risks in China and other EMs. I think the market is insanely blasé about the risks at home. I think political risk everywhere is mispriced.

Tobias: What are you going to do?

Bill: I don’t know. That’s the thing. you live one– These are the cards. So, I can run around and stick my head in every single sand pile that there is, or we can talk about what we– [crosstalk]

Tobias: You’ve got a handicap on, right?

Bill: Yeah.

Tobias: It’s the whole thing is a handicapping job. We got imperfect information. We don’t know what’s going to happen in the future. We’re looking at different regulatory regimes. We’ve got a regulatory regime here. Google is currently under– I don’t know what the exact word is, I don’t want to say indictment but Google, its search is confronting antitrust. It’s going to go through that process. Next year, I think it all kicks off, they filed last year. I don’t know what the outcome of that is. I think that if you look at Microsoft, the outcome’s not going to be too bad, but the US has had antitrust action against Microsoft too in the early 2000s, and there was antitrust action against Ma Bell in the 80s.

Jake: Standard oils, the classic.

Tobias: Standard Oil was the original, but still– [crosstalk]

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