Last May, I compared Tencent (OTC:TCEHY) to Apple (NASDAQ:AAPL). I owned both stocks at the time, but I declared that Tencent’s better diversification, lower exposure to the pandemic, and stronger growth rates all made it a more compelling buy than Apple.
But over the past 12 months, Tencent’s stock advanced less than 40% as Apple’s stock rallied nearly 60%. I also sold my position in Tencent earlier this year but held on to my shares of Apple.
Let’s see why Apple outperformed Tencent, how several recent developments dampened my enthusiasm for the Chinese tech giant, and if Apple will remain the stronger investment over the next 12 months.
Tencent’s growth masks some serious challenges
Tencent initially seems like a great growth stock. It owns WeChat, China’s top messaging platform and a walled ecosystem for millions of Mini Programs — which enable users to play games, make payments, buy things, hail rides, and more without ever leaving the app.
It’s the largest video game publisher in the world, and its online payment platform WeChat Pay shares a near duopoly in its market with Ant Group’s AliPay in China. It owns Tencent Video, one of China’s top streaming video platforms, most of Tencent Music (NYSE:TME), the country’s largest streaming music platform; and Tencent Cloud, its third largest cloud platform after Alibaba (NYSE:BABA) Cloud and Huawei Cloud.
But that’s not all. It’s also on the verge of merging Huya (NYSE:HUYA) and Douyu (NASDAQ:DOYU), China’s two largest esports streaming platforms; it owns a long list of smaller apps, and its investment portfolio reaches far beyond its home market.
Tencent’s revenue rose 28% in 2020 — as its value-added services, advertising, and fintech and business services all generated double-digit sales growth — and its adjusted earnings rose 30%. Analysts expect its revenue to rise 21% and 27%, respectively, this year.
Those growth rates are impressive, but three things are dragging down the stock. First, Chinese regulators targeted Tencent over the past year with fines over previously unapproved acquisitions, tighter scrutiny of its upcoming deals, and threats of tighter regulations for its fintech business.
Second, it faces unpredictable regulatory threats in the U.S., where a newly passed law could force Tencent’s unsponsored ADR shares off the OTC market if it doesn’t comply with new auditing rules within the next three years. U.S. regulators are also reportedly probing its stakes in Riot Games and Epic Games. If Tencent is forced to divest those big investments, its gaming revenues could plunge.
Lastly, rising bond yields are sparking a rotation from growth to value stocks. That sell-off reduced Tencent’s forward P/E ratio to 25, but the recent regulatory headwinds could keep the bulls at bay.
Apple has a clearer path forward
Apple’s revenue and earnings rose 6% and 10%, respectively, in fiscal 2020, which ended last September. It mainly relied on higher revenues from its Macs, iPads, Apple Watches, AirPods, and software services to offset its 3% decline in iPhone sales.
But in the first half of fiscal 2021, Apple’s revenue surged 34% year over year. Its iPhone sales jumped 34%, thanks to robust demand for the iPhone 12 (its first family of 5G devices), as all of its other business segments generated high double-digit sales growth.
Apple’s services segment, which includes Apple Music, Apple TV+, Apple Arcade, Apple News+, and other services, also surpassed 600 million paid subscribers late last year. The growth of that ecosystem will continue to lock in users while planting the seeds for future growth initiatives like augmented reality and connected cars.
Apple’s earnings grew 63% year over year in the first six months, even as it ramped up its investments in new services. It expects the global chip shortage to reduce its revenues by up to $4 billion in the third quarter, mainly due to its impact on Mac and iPad shipments, but that would only account for about 1% of its estimated revenues for the full year.
Wall Street expects Apple’s revenue and earnings to grow 29% and 59%, respectively, this year. The stock trades at 24 times forward earnings, and it arguably faces fewer near-term challenges than Tencent.
That said, Apple still faces a few unresolved conflicts, including legal challenges against its App Store fees, clashes with advertisers over its recent privacy changes to iOS, and antitrust probes in the U.S. and Europe.
Apple also remains heavily dependent on the iPhone, which still generated over half its revenues in the first half of the year. But with $204 billion in cash, cash equivalents, and marketable securities on hand, Apple can still easily expand beyond the iPhone with big investments and acquisitions.
The bottom line
I sold Tencent because it was becoming the next big antitrust target in China after Alibaba. It’s also attracting too much attention from U.S. regulators.
Meanwhile, Apple started a fresh growth cycle with the iPhone 12, and its other businesses continue to expand as it returns most of its free cash flow to investors via buybacks and dividends. Therefore, I’m sticking with Apple and backing away from big Chinese tech stocks like Tencent this year.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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