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After a challenging year for several theme baskets, I'm ready to embrace certain companies within the High-Growth Multiple and Chinese Internet baskets for a potential recovery in 2022
As we enter the first several weeks of trading in 2022, we have a fresh start to the year with several key investment themes from 2021 most likely still intact.
We are now in an environment of above-trend inflation, an re-emergence of Fed hawkishness, and relatively strong economic data in the U.S. with mixed data from China.
From this environment, the FAAMG Mega Cap stocks, cyclicals, financials, and energy have done well in 2021 while popular baskets such as high-growth, Chinese Internet, and ARKK-related stocks have mostly fallen out of favor.
Although the current environment puts these out-of-favor theme baskets in a more challenging position to outperform, finding alpha from certain companies in these baskets is now more likely because of light investor positioning and cautious sentiment.
I have put together a list of 10 companies that I believe have the characteristics of high risk/high return profiles. These companies are all high-quality but the current macro environment has stunted their share prices. To be sure, I am not advocating that a direct buy & hold position at this very moment today will deliver market-beating returns. But I do believe buying these companies at the right time could definitely put risk/reward clearly in your favor.
Here's my top 10 High-Risk/High-Reward stocks for 2022. Each name will be given an explanation on where the company stands today, a brief rationale of why it could outperform, and the risks you must know about.
My top 10 high-risk/high-reward stocks for 2022
#1: Alibaba (BABA)
Where Alibaba stands today: Alibaba's share price has been suppressed by a powerful combination of China's slowing consumption growth, softer than expected company earnings, restrictions on institutional investors allocation in China, and continued uncertainty into U.S. & China geopolitics.
Why it could outperform: The Chinese Internet sector is going through tremendous change in China amidst President Xi's current regulation reform in China. The bulk of these regulations have taken place in 2021, with the remaining regulations in the future to be felt more as "increments" than full-scale changes to how businesses can operate.
As of now, there are most likely limits to allocations to Chinese equity exposure among institutional investors due to the current risks. Once these benchmark limits are moderately lifted, we should see Alibaba (which is the proxy of Chinese equity sentiment) begin to recover.
We have also seen expansion of Alibaba's share price volatility. This implies that quick 10-30% bounces can happen in a matter of days. This type of return profile is nearly impossible to find among large cap equities in today's valuation environment.
The risks: Given that the current sentiment towards China continues to be deeply negative, It's possible that Alibaba experiences downside to the $90-$100 level (15-20% from here) last experienced in 2017 before fully bottoming from there. Fundamentally speaking, a recovery in Alibaba's earnings is likely to take place in the 2H of 2022 and beyond as R&D slows down and China's macro consumption recovers.
#2 Tencent (OTCPK:TCTZF)
Where Tencent stands today: All things considered, Tencent has performed far better than the general Chinese Internet Sector (which can be represented by the ETF KWEB). The company's business model is far more diversified with segments ranging from Gaming, Ads, to FinTech. And its leadership has stronger relationships with the Chinese Government.
Why it could outperform: We all know the valuation of Chinese equities is quite depressed, and Tencent is no exception. What makes Tencent's low valuation more attractive is that they have more room to execute in some of their segments since their business model will eventually be global. Although I like Alibaba and believe Alibaba offers more upside potential from here, I also believe BABA comes with more risk. In addition, Tencent is less impacted by fears of delisting (a narrative I don't buy into anyway) because it trades in the OTC markets.
The risks: Tencent's future will also be largely influenced by sentiment surrounding the Chinese Internet sector. Although I do believe Tencent has significant long-term potential to break out, I believe in the intermediate term, the company is likely to be range bound with +/-15% moves in a trading range from its current share price. That said, a 15% upward move in a large-cap high quality name is respectable given that indices are at their peaks.
#3 Roku (ROKU)
Where ROKU stands today: ROKU is one of the most contested names in the high-growth basket today. They recently renewed their deal with YouTube (GOOG) (GOOGL), and this serves as a very strong win for their product strategy and user engagement. That said, the high-growth theme basket along with Cathie Wood's ARKK stocks has been under pressure due to investors' capital allocation towards FAAMG, cyclicals, and the broader indexes.
The name of the game for ROKU will be their ROKU Original Channel and the content that comes inside it. They keep 100% of the ads served in their original programming while only 30% from outside streaming services.
Why it could outperform: ROKU is not for the faint of heart as investors in the name will know that the company moves +/- 3-5% on sometimes no fundamental development. The shares are being hotly debated by bulls and bears on the future of its role in the secular shift towards streaming.
That said, ROKU might eventually be a larger player in original film production and there are rumors that they may be interested in Lionsgate to add onto their content library from their Quibi acquisition.
While it is a big "if", if indeed ROKU's Original Channel content succeeds, the company's upside from here will be very large.
The risks: The high-growth basket has fallen out of favor, and ROKU is inside this basket. The Fed's current tightening schedule of 3 rate hikes in 2022 is not helpful for ROKU's narrative, and represents a threat to the bull case thesis for the company since a large amount of its future profits are expected to take place in the future.
#4 New Oriental (EDU)
Where it stands today: 2021 has not been kind to the Chinese Education sector, and has essentially rendered this sector mostly un-investable for institutional buy & hold investors. Most companies within this sector will end up failing, but among the ones that do survive, there presents great opportunities. New Oriental is likely to be one of the rare survivors.
Why it could outperform: I know what you're thinking. You're thinking that the Chinese Tutoring Market is finished, and you're largely correct. However, do note that I'm vouching for New Oriental specifically and not necessarily other tutoring names like TAL Education.
Simply put, I happen to believe that New Oriental's Founder & CEO Yu Minhong has what it takes to slowly transition the company into its next stage in Agricultural E-commerce. The Founder clearly understands that Chinese Education has entered another chapter, and he is not fighting trends that cannot be easily reversed. Instead he is putting his time, resources, and energy towards developing the agricultural business for rural farmers in the name of Common Prosperity.
Over time, I do believe those efforts will pay off, and this is why I believe out of the entire Chinese Education sector, EDU is one of the few that will survive and successfully pivot.
The risks: The risks for EDU continue to be very large. Business pivots are already very challenging to execute, and to have EDU successfully transition to an entirely new sector will take time. This means the big risk for investors is opportunity cost. Don't be lured into EDU's low prices and allocate an appropriate amount of capital if you believe in their turnaround story. This name continues to track the sentiment of the Chinese internet sector, so that is a consideration as well.
#5: Twitter (TWTR)
Where it stands today: Twitter has disappointed many investors, and even though I was able to reduce some of my position in the mid 60s for a neat profit, a portion of my other position is now deeply in the red. I was disappointed to see the company's share price languish because their projections didn't match their outcomes.
Earlier in 2021, the company reiterated confidence that they would grow to 315M users by 2023. It's now the beginning of 2022, and the company (currently at 210M+ users) is not even close to achieving that goal.
A lack of trust in management's projections, and slower than expected build out of its direct response products has made TWTR an under-performer in 2021.
Why it could outperform: Although investors have sidelined TWTR, there are several reasons it could make a turnaround. The company's valuation isn't demanding, and the social network plays a key role in communication media in today's economy. In addition, any positive execution from the new management on the direct-response product or higher than expected user growth is likely to send TWTR's shares much higher from here.
The risks: Poor product execution and inaccurate management projections have plagued TWTR and its shareholders. This continues to be key risks for the company.
#6: Netflix (NFLX)
Where it stands today: Netflix is the under-performer within the FANG basket in 2021. The company has incredible operating leverage where every new subscriber has a disproportionately bigger impact on net income than its cost structure. The company's subscriber growth has been very solid with recent successes in its content release for its U.S. and International segments.
Why it could outperform: For Netflix (and ROKU), the core fundamental drivers is the subscriber growth of their paid subscription plans. High quality (and addictive) content is the secret in continuing to grow subscribers and therefore EPS. Netflix's new high quality shows and its international content particularly its original Korean Drama content provide it a strong competitive advantage for content compared to other streaming services.
The risks: Although I am personally a fan of Netflix, I recognize that consuming too much content on Netflix potentially can impact productivity. This means that throughout the year, Netflix's subscriber growth will go through ebbs and flows as groups of people decide to opt out of spending time on NFLX and rather reallocate their time elsewhere. In other words, Netflix is competing for people's time.
Netflix's content is outstanding and I believe from a content perspective, the company for now has little competition. That said, NFLX must spend a lot of its capital towards constantly producing new blockbusters and this means the company is dependent on the outcomes of its content efforts.
#7 Match (MTCH)
Where it stands today: In addition to its brand as the king of online dating, Match has expanded into the social networking business with its acquisition of HyperConnect. The company is adding social networking to its portfolio of products in addition to its two flagship products Tinder and Hinge.
Why it could outperform: Match has redesigned the dating apps to produce more of an incentive to sign up for its paid subscription tiers. The free versions of the apps on Tinder and Hinge now have more limitations and restrictions on users ability to chat and connect. As a result, Tinder is growing its paid subscribers rapidly and could be a narrative for the reopening trade in 2022.
The risks: In terms of the current dating landscape, Online Dating has not recovered from pre-pandemic levels and Match's valuation of 14X sales will be highly contested by both bulls and bears.
#8 Spotify (SPOT)
Where it stands today: Spotify is the king of music streaming and its subscriptions model and ads business has very unique value propositions for both users and advertisers. The company does face increasing competition in Google and Amazon's (AMZN) music services, but SPOT has a unique value proposition of having the largest market share as well as more intense user engagement than the competition.
Why it could outperform: Apple's iOS privacy tracking is likely to weaken the advertising results of traditional social media ad spend on Facebook. Advertisers will likely experiment with alternatives, and Spotify could be a beneficiary. Spotify's push into podcasting positions the product to have stronger user loyalty and engagement. In addition, SPOT could be an acquisition target.
The risks: I believe the constant battle that Spotify has with artists over royalty fees is a source of contention. With royalties at 70-75% of revenues, the cost of revenue via royalties give Spotify less room to impress the Street without revenue growth and high active monthly user growth. I also consider Spotify as also a stock inside the high-growth multiple basket. As a result, sentiment around valuation can impact stocks like Spotify
#9 NIO (NIO)
Where it stands today: The EV trade was very hot in 2020 but has fallen from grace in 2021. Nio's share price has been slashed by 35% in 2021 as valuations and expectations reset. The entire EV sector has been under pressure as the speculative froth has been removed.
Why it can outperform: Electric Vehicles and Clean Energy is a secular growth trend globally. NIO's EV cars are at the core of this long-term narrative. NIO's positioning within China is also favorable as its deliveries are now past 10,000 cars per month. NIO's valuation is not demanding, and if the company executes well, NIO's share price has upside from here.
The risks: In order to maintain delivery growth, NIO needs to navigate the current supply chain issues in China well. For now, Current rivals XPeng (XPEV) and Li Auto (LI) are now ahead of NIO in terms of delivery growth. This creates friction in terms of capital allocation within the EV theme basket and whether institutional investors place their bets with NIO.
#10 Shopify (SHOP)
Where it stands today: Shopify is probably one of the top performing e-commerce stocks in 2021, although this type of return was achieved within a high-volatility trading range. The company is structurally positioned to benefit from the growing tailwinds of digital and e-commerce. The total addressable markets for Shopify are increasing over time and the company is positioned to benefit from this trend.
Why it can outperform: There are very few companies with Shopify's revenue growth profile inside a secular growth market. This creates a powerful narrative for investors to stay invested since the company is a winner inside an ever-expanding market. Shopify is likely to outperform the general tech sector in a continued bull market environment because of its high beta but be aware that the company can suffer larger drawdowns than the Nasdaq in a downturn.
The risks: Shopify's valuation is highly dependent on its revenue growth and the stability of its gross profits. At 41X sales, Shopify is definitely in the high-growth basket theme. Because of their strong execution, Shopify has avoided the general downturn in this theme basket but its share price gains has come from a very large trading range. This means that continued share price appreciation will most likely happen in a very volatile manner.
Final Thoughts
I think it's important in 2022 to be invested in both indexes and high-quality companies given elevated valuations and macro risks. The list I presented is a list I'm personally invested in, and although every name here offers the potential for high returns, they all present higher than average risk.
I look forward to seeing you in my comments section below.
