The Best Chinese Stocks to Buy

To say Chinese stocks have struggled lately is an understatement: The Morningstar China Index has lost nearly 17% annually during the past three years, while the Morningstar US Market Index has gained almost 8% annually during the same time period, as of April 10.

What happened?

Morningstar Indexes strategist Dan Lefkovitz explains:

“In the years following the 2007-09 financial crisis, China became the largest emerging market. By the end of 2020, Chinese internet companies Alibaba BABA and Tencent TCEHY were among the 10 largest public companies globally. Then came a government crackdown, which saw leading companies’ market values slashed. At the macroeconomic level, China was widely anticipated to bounce back strongly in 2023 from “Zero Covid” lockdowns, but a property-market downturn and other woes undermined recovery.”

Long-term investors willing to accept the regulatory and geopolitical risks that come with investing in China will find many undervalued Chinese stocks of well-managed, competitively sound companies to choose from.

To come up with our list of the best Chinese stocks to buy now, we screened for:

• Chinese companies whose stocks trade on a US exchange.
• Chinese companies that earn wide Morningstar Economic Moat Ratings. We think companies with wide economic moats should remain competitive for 20 years or more.
• Chinese stocks that are undervalued, as measured by our price/fair value metric.

5 Best Chinese Stocks to Buy Now

The stocks of these Chinese companies with wide economic moats are the most undervalued according to our metrics as of April 10, 2024.

1. Tencent TCEHY
2. Yum China YUMC
3. Baidu BIDU
4. JD.com JD
5. Alibaba BABA

Here’s a little more about each of the best Chinese stocks to buy, including commentary from the Morningstar analyst who covers the company. All data is as of April 10, 2024.

Tencent

• Morningstar Price/Fair Value: 0.44
• Morningstar Uncertainty Rating: High
• Morningstar Capital Allocation Rating: Exemplary
• Industry: Internet Content & Information

Tencent is the cheapest stock on our list of the best Chinese stocks to buy. The stock of this company from the content and information industry is trading 56% below our fair value estimate of $90. Management earns an exemplary capital allocation rating.

Over the past decade, Tencent has capitalized on the industry shift toward mobile gaming. The firm owns some of the world’s most popular titles, like Honor of Kings and PUBG Mobile. To date, games remain Tencent’s primary monetization model—as we estimate more than 40% of the group’s operating income comes from this segment. Tencent should continue to leverage its unrivaled access to user data and financial capital to create innovative, high-quality, and long-cycle games with a mobile-first approach.

Outside of games, other key businesses under the Tencent empire include WeChat, QQ, WePay, music streaming, on-demand cloud, and a host of other ventures. We see a tremendous amount of untapped value in WeChat, as it continues to increase monetization through advertising and acts as a major gateway for other internet services (payment, delivery, insurance, and so on) looking to access the 1.2 billion-plus WeChat users.

Given WeChat's huge and engaged user base, advertisers will continue to find it one of the top marketing channels. We think there are ample advertising revenue opportunities ahead, driven by 1) rising advertising inventory, 2) higher ad loads, and 3) improving ad-targeting efficiency.

While games and advertising will remain Tencent's core cash flow driver, we think the firm's investments in other areas (cloud storage, business services, enterprise software, and so on) also offer long-term value-creation potential. Given the size of China's economy and the prevalence of digital adoption, we surmise that there are enormous opportunities ahead for enterprise technology (think Zoom, Slack, and Teams), and Tencent will most likely turn these services into recurring revenue streams.

Tencent is also an investment powerhouse, and it loves using deals to expand its reach. Once invested, Tencent tends to add value through highlighting investees’ services on WeChat and other in-house traffic platforms—reducing customer acquisition costs while helping them scale rapidly. This strategy has paid off nicely, as external investments have generated an estimated internal rate of return of above 20% over the past decade.

Yum China

• Morningstar Price/Fair Value: 0.48
• Morningstar Uncertainty Rating: Medium
• Morningstar Capital Allocation Rating: Standard
• Industry: Restaurants

Yum China operates in the restaurant industry and earns a standard rating for management’s capital allocation activities. Yum China stock is 52% undervalued; we think the stock is worth $80.

The covid-19 pandemic provided Yum China the opportunity to accelerate store openings at more favorable lease terms. The company added more than 3,700 locations from 2020 to 2022, equivalent to a 36% increase from 2019. Now that China’s zero-covid-19 policy is in the rearview mirror, we expect these new restaurants to not only deliver significant incremental revenue but also be accretive to the overall margins. Over the next several years, we expect Yum China to speed up new unit openings. We share management’s view that there remain plenty of expansion opportunities in lower-tier cities—evidenced by nearly 1,200 Chinese cities still with no KFC presence.

Over the longer term, we believe there are several opportunities for Yum China to gain a share in the fragmented, USD 700 billion Chinese restaurant market. In China, chains account for roughly 18% of restaurant spending, compared with 61% in the US and 34% across the globe. Our conviction in rising fast-food penetration is underpinned by three long-term secular trends: longer working hours for urban consumers; rapidly rising disposable income; and ever-smaller family sizes. Coupled with strong brand recognition and an unrivaled supply chain, Yum China is set to be the prime beneficiary of growing Chinese fast-food spending. We’re also optimistic about Yum China’s various top-line drivers, including value platforms, menu innovations, new restaurant formats, enhanced digital marketing efforts (underscored by 300 million loyalty program members), unrivaled delivery capabilities, and nascent brand expansion potential in Lavazza, Taco Bell, and Huang Ji Huang.

At its 2021 investor day, Yum China management committed a five-year budget of USD 1 billion-USD 1.5 billion to technology and digital development. We believe the company is beginning to reap the fruits of its investments. We believe a significant amount of cost savings will be passed through to the bottom line simply because these investments at scale are not likely to be replicated by competitors. This underpins our forecast for operating margin expansion over the long term.

Baidu

• Morningstar Price/Fair Value: 0.56
• Morningstar Uncertainty Rating: High
• Morningstar Capital Allocation Rating: Standard
• Industry: Internet Content & Information

Baidu is 44% undervalued relative to our $183 fair value estimate. This top Chinese stock from the content and information industry earns a standard capital allocation rating.

Baidu’s online advertising business accounted for 73% of Core revenue in 2022 and will be the main source of revenue in the medium term given its dominant market share for search engines, but we believe unless it can develop another industry-leading business, it could face long-term challenges for advertising dollars from growing competitors such as Tencent and ByteDance. Baidu is increasingly shifting its focus toward its cloud business and now also artificial intelligence, with its Ernie generative AI model becoming its flagship product. We believe that Baidu is an early mover and should benefit from China’s AI development, but whether Ernie will be the long-term leader will depend on execution as we believe other resource-heavy companies have the potential to catch up to Baidu if there are missteps in its generative AI development.

While Baidu is transforming its identity by investing in generative AI, cloud, and autonomous driving, commercialized success remains to be seen. There are encouraging signs of its AI cloud monetization growing to 19% of core revenue in 2022 from 12% in 2020. However, despite sharp growth, we expect Baidu to face competition in the cloud from industry leaders Alibaba, Huawei, and Tencent, which all have greater market share than Baidu. Despite a potential total addressable market for autonomous driving that is 9 times its online advertising per management, commercial success is highly uncertain as revenue remains immaterial, and mass scale adoption or time-to-market are unclear.

Its streaming video service, iQiyi, continues to be a margin drag on Baidu’s business due to a high content cost. The business constantly needs to develop or acquire new content to prevent customer churn. We’re less confident of its outlook than the Core product due to a low barrier to entry and numerous competitors. Membership has remained stagnant at 105 million to 106 million subscribers for the last five quarters, and therefore, we believe long-term growth is limited.

JD.com

• Morningstar Price/Fair Value: 0.58
• Morningstar Uncertainty Rating: High
• Morningstar Capital Allocation Rating: Exemplary
• Industry: Internet Retail

This Chinese company operates in the internet retail industry. JD.com stock trades 42% below our fair value estimate of $46. The company receives a Morningstar Capital Allocation Rating of Exemplary for the quality of its balance sheet, investments, and shareholder distributions.

JD.com offers authentic products from its online first-party, or 1P, business with speedy and high-quality delivery service. It adopts an asset-heavy 1P model with self-owned inventory and largely self-built logistics, complemented by an asset-light third-party, or 3P, model. By comparison, its competitor Alibaba relies mostly on a 3P model. Underperforming Pinduoduo and Douyin, JD’s GMV/online retail sales of goods has decreased from 30.7% in 2021 to 29.2% in 2022. To reinvigorate growth, JD wants to change customers’ mindshare of JD as an everyday low-price platform and has launched a CNY 10 billion subsidy program to attract price-sensitive customers. It is removing sales of nonstrategic low-margin products from the 1P business and allowing 3P merchants and business partners to provide these products instead. JD.com is also streamlining its organization to increase its ability to respond to quickly changing market dynamics. We expect JD.com to see weaker sales growth this year amid these changes.

In the medium term, we expect to see stable margins, after cutting much of its unprofitable businesses such as community group purchase, Jingxi, and international businesses in 2022. JD.com will continue to put more emphasis on high-quality profitability instead of low-quality growth. JD’s logistics business JDL became an independent business unit that opens its services to third parties. JDL management will be squarely focused on profitability as well and has achieved positive non-IFRS net profit in 2022. As the logistics business gains scale and reaches higher capacity utilization, we will see gross profit margin improvement.

JD is a long-term margin expansion story driven by increasing scale from its 1P and 3P businesses. Larger scale in each category will increase its bargaining power with suppliers. Since 2016, JD no longer fully reinvests its gains from improving scale and is committed to delivering annual margin expansion in the long run. The increase in mix from higher-margin third-party platform business and efficiency of scale will help lift margins.

Alibaba

• Morningstar Price/Fair Value: 0.79
• Morningstar Uncertainty Rating: Very High
• Morningstar Capital Allocation Rating: Standard
• Industry: Internet Retail

Alibaba rounds out our list of the best Chinese stocks to buy. This stock looks 21% undervalued compared with our $94 fair value estimate. This internet retail company’s stock receives a standard capital allocation rating.

Alibaba is losing market share to PDD Holdings and Douyin in the China e-commerce business, and we don’t see a quick fix in the near term. Alibaba’s number of annual active consumers in the China retail marketplace was surpassed by PDD in the fiscal year ended March 2021. Meanwhile, Douyin has gained share from Alibaba especially in the beauty and apparel categories in recent years, and entered the traditional search-based e-commerce space, competing directly with Alibaba. The number of annual active consumers at Alibaba is close to the ceiling in China. Alibaba’s gross merchandise volume to China’s online retail sales of goods ratio was 62% in the year ended March 2023, down from 72% in the year-ago period. We believe Alibaba’s marketplace monetization rates will decline in the long run, due to mix-shift toward Taobao, which has lower take rate compared with Tmall, and more competition.

In our view, the Taobao/Tmall marketplaces remain as Alibaba's core cash flow driver and can support the expansion of AliCloud as well as the firm’s globalization strategy, which offers long-term growth potential. While AliCloud will remain in investment mode in the medium term, downsizing low-margin businesses can drive segment margins higher over time. On globalization, Alibaba International Digital Commerce Group’s year-on-year revenue growth has been strong recently, thanks to AliExpress' expanding cross-border business.

We expect Alibaba to return more capital to shareholders and increase its return on invested capital after divestments of noncore investments. We are pleased that Alibaba has upsized its share-repurchase program by USD 25 billion for the next three fiscal years (until end-March 2027) to USD 35.3 billion. Management targets to lift ROIC (based on Alibaba’s calculation) from single digits in fiscal 2023 to double digits in the next few years. Alibaba had sizable cash and equivalents and investments of CNY 829 billion on its balance sheet as of December 2023.

How to Find More of the Best Chinese Stocks to Buy

Investors who’d like to extend their search for top Chinese stocks can do the following:

• Read the latest news about notable Chinese stocks from Morningstar Equity Analysts Ivan Su and Chelsey Tam.
• Review the top holdings of the Morningstar China Index for ideas to research further.