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With years of evolution, China’s internet population is still growing at 15% annually while that for the US is already close to zero. Out of the many Chinese internet related stocks, my favorite pick is Tencent Holdings (TCEHF.PK). Tencent still has a lot of room to grow in both increasing market penetration and by introducing new services.

I am a strong believer of Peter Lynch’s investment approach in which he applied his observations from daily life to his investment picks. Here is how I applied the same in my Tencent analysis.

Last month I attended a conference in Shenzhen (in Southern part of China, adjacent to Hong Kong) which was about intellectual property protection. In the event I met a guy from Tencent who carried the title of Patent Manager on his namecard. The guy is about than 30 years old, locally born in Shenzhen, attended university in France, speaks and reads fluent Cantonese, French, English (of course also Putonghua).

I was very impressed with what I heard in both my private conversation with him and also in his open discussion with the floor audiences (he was one of the event speakers) and that has further enhanced my confidence in this stock.

  • I've never seen a PRC internet company with such a position (Patent Manager), there are many of them in companies like Huawei or ZTE, but not with an internet media company like Tencent. This shows how Tencent is above par in the aspect of using patent to protect its business edge. As a matter of fact, Tencent is already using its patent muscle to fend off competitors in China. In a very recent case (Tencent vs. Beijing PICA Co Ltd) in which Tencent sued PICA for providing its customers with Tencent IM services by accessing Tencent's server without its authorization, the court ruled that PICA has infringed Tencent’s IP rights and awarded Tencent 2M Yuan compensation. Though 2M Yuan (~US$250K) is not that much, this nevertheless has sent a very strong message to all potential infringers who compete with Tencent.
  • He told us that Tencent has a very strong sense of patent in mind when they design new services; in such a competitive internet environment in PRC, it's a very good attempt to protect its ideas by patent.
  • I can sense (instead of what he told me) that the Tencent gentleman I met is very proud of and happy working for Tencent. Having a team of happy employees is nowadays a critical success factor for technology companies that demand innovation and commitment.
  • I also learned that Tencent has a “QQ Lab” initiative. “QQ” is the service brand name for Tencent’s IM service in China. Its QQ Lab is a similar approach to Google (NASDAQ:GOOG) Lab in which new services are nurtured. If you ask me to pick a Chinese internet stock with potential as good as Google, I definitely will pick Tencent rather than the direct Chinese search engine comparable Baidu (NASDAQ:BIDU). I see a lot of continuous innovations coming from Tencent but I don’t see the same from BIDU.
  • Apart from that, a friend of mine recently showed me a Tencent recruitment advertisement for its openings in advertising sales positions. At first glance this seems to be a trivial daily matter. However, the advertisement was posted in Media, a very popular newspaper for the advertising industry in HK. This again tells me they do have someone who really knows the field. At least I've not seen Yahoo Hong Kong doing the same thing; I only see Yahoo (NASDAQ:YHOO) HK’s recruiting advertisement appearing in generic newspaper. Sometimes trivial matters do tell something important.

    For US based investors, instead of buying the pink sheet which lacks liquidity, you can in fact directly invest in Hong Kong listed stocks. Hong Kong market is open to all investors. For example, ETrade has announced that it is extending its service to cover several new markets (including Hong Kong) and that is open to US investors. The Hong Kong Dollar is pegged to the US dollar and hence there is no currency risk. The Hong Kong dollar is also a freely floated currency (unlike the Chinese Yuan which is not yet floated) so you have no worry of forex. control.

    TCEHF 1-yr chart
    TCEHF

    Source: Why Tencent Holdings Is Worth So Much More Than That