Skip This Chinese Internet ETF And Buy These 2 Stocks Instead

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Includes: CMCM, FDN, KWEB, VIPS
by: Steve Auger

Summary

KWEB provides exposure to internet companies benefiting from increasing domestic consumption by China's growing middle class. But KWEB’s performance over the last 3 years has been a disappointment.

The falling Chinese Yuan partially explains the ETF’s poor performance, but also stock selections that trade earnings for sales growth, a strategy similar to that of Amazon.

Comparing KWEB to FDN, KWEB has better aggregate debt-to-equity, sales growth, and cash, but has worse ROE, -3.24% as opposed to 4.84% for FDN.

Buying two stocks VIPS and CMCM is suggested instead of the entire ETF, taking advantage of stock fundamentals and stock technical.

Put option strategies are suggested for both stocks, providing short term income generation.

The KraneShares CSI China Internet ETF (NYSEARCA:KWEB) provides exposure to internet companies benefiting from increasing domestic consumption by China's growing middle class, companies that provide services similar to Google (NASDAQ:GOOG), Facebook (NASDAQ:FB), Twitter (NYSE:TWTR), eBay (NASDAQ:EBAY), Amazon (NASDAQ:AMZN), and other American internet giants. When I initially started researching this ETF I was very excited to discover I could invest in this fast-growing sector of the Chinese economy. But I ended up disappointed with KWEB after examining its performance over the last 3 years.

Stock chart for KWEB and FDN

Not only did KWEB underperform the USA-based First Trust DJ Internet Index ETF (NYSEARCA:FDN), but KWEB did not really appreciate much in price at all, very disappointing considering the tremendous growth in Chinese internet use over the last 3 years. One reason for KWEB's lack of performance is the declining worth of the Chinese Yuan as shown below.

CYB stock chart

The WisdomTree Chinese Yuan Strategy Fund (NYSEARCA:CYB) has dropped in price from $25.50 to $24 in the last 3 years, or approximately 6%. But the falling Yuan does not entirely explain the lack of performance since FDN rose about 43% over the same time period.

Using Portfolio123, I calculated some basic aggregate fundamentals for the two ETFs. They are shown in the table below.

Aggregate fundamentals for KWEB and FDN

Aggregate Fundamentals

KWEB

FDN

Cash and Equivalent

$1.93b

$919m

Debt-to-Equity

0.21

0.45

Return on Equity (ROE)

-3.24%

4.84%

3-Year Comp Sales Growth

20.24

18.07

KWEB has better underlying fundamentals than FDN everywhere except for where it counts, the bottom line. The ROE is -3.24%. This could be explained as Amazon-style growth, where management makes sales growth a priority over making a profit. Fair enough, that would explain the lack of share price performance. Another explanation is the rampant corruption apparent in many Chinese companies which could partially explain the poor performance.

Instead of buying shares of the Chinese internet ETF, it might be more profitable to pick stocks that are held by KWEB, and investing in those. Details on two companies that I like are provided below.

Vipshop Holdings Ltd

Vipshop Holdings (NYSE:VIPS) is an online discount retailer that offers branded products to consumers in China through flash sales on its vip.com Website. Through its flash sales model, the Company sells limited quantities of discounted branded products online for limited periods of time. The Company offers diversified product offerings from over 17,000 domestic and international brands, including apparel for women, men and children, fashion goods, cosmetics, home goods and other lifestyle products.

VIPS has a staggering 3-year compound annual growth of 107.7%, and an ROE of 39%.

VIPS stock chart

As shown in the stock chart above, VIPS is sitting on a major support level, and the share price will likely go up from here.

Risks

There is one negative for this company and that is the total debt. The ratio of debt to equity is 0.96. Rising interest rates could put a damper on share price appreciation. I recommend that if a position in this stock is initiated, that it be closed out immediately if the price drops down to the $9.50 level.

Short term play

An alternative to buying shares in VIPS is to sell out-of-the-money Put options. You should be able to sell Feb 17 Puts with a strike price of $11 for $0.50. The recent stock price is $11.49. This will give more than 4% profit in two weeks if the stock price remains above $11. Otherwise, if the price falls below $11, your options will be assigned and you will own shares at a discount.

Cheetah Mobile

Cheetah Mobile Inc. (NYSE:CMCM) provides a suite of applications that provides real time protection against security threats and optimizes mobile and PC Internet system performance. The company also offers other products, such as mobile advertising, web and mobile games, and cloud-based data analytics engines.

CMCM has a negative ROE of -3.01% but I can overlook that given the massive 3-year compound sales growth of 130.88% and low debt-to-equity ratio of 0.10.

CMCM stock chart

The recent stock price of $9.96 is above the major support level of $9.00 as shown in the chart above. The price consolidation in the form of a wedge means that the price will soon break out or break down. Given the tremendous growth in sales and low debt ratio, I believe that the price will break out. But in any case, the position should be closed if the price drops below the support level of $9.00.

Risks

CMCM has been expanding aggressively through acquisitions and has a global reach. Regardless, investments in Chinese companies is always risky. Corruption, poor product acceptance, or an unexpected poor financial report could cause the price to tumble.

Short term play

An alternative to buying shares in CMCM is to sell at-the-money Put options. You should be able to sell Feb 17 Puts with a strike price of $10 for $0.65. The recent stock price is $9.96. This will give more than 6% profit in two weeks if the stock price is above $10. Otherwise, your options will be assigned and you will own shares at a discount.

Summary and Conclusions

KWEB provides exposure to internet companies benefiting from increasing domestic consumption by China's growing middle class. But KWEB's performance over the last 3 years has been a disappointment.

The falling Chinese Yuan partially explains the ETF's poor performance, but also stock selections that trade earnings for sales growth, a strategy similar to that of Amazon.

Comparing KWEB to FDN, KWEB has better aggregate debt-to-equity, sales growth, and cash, but has worse ROE, -3.24% as opposed to 4.84% for FDN.

Buying two stocks VIPS and CMCM is suggested instead of the entire ETF, taking advantage of stock fundamentals and stock technical.

Put option strategies are suggested for both stocks, providing short term income generation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.