• Brett Schafer

Why I Sold My Shares of JD.com

“Only when the tide goes out do you discover who has been swimming naked” – Warren Buffett.

Buffett likely wasn’t the first person to ever say something like this (as with all vague quotes), but the meaning holds true nonetheless. What he is eloquently saying is, that, in financial markets, when shit hits the fan, you realize who has just been bullshitting this entire time.

At this point in the cycle, those bullshitters reside in China.

Last week, Luckin Coffee, one of the hot Chinese IPOs, admitted to faking over half (half!) of its sales in 2019. The stock was down over 80% in one day, is now down almost 90%, and is facing a margin call.

Today, Tal Education admitted they “discovered” employees were inflating sales numbers with 3rd parties. The stock is down big after-hours and should plummet tomorrow.

And don’t forget the new allegations against iQIYI (a stock I used to own, whoops) around faking sales/subscriber numbers.

It’s not looking good for Chinese listed ADRs. I frankly don’t think I can trust any of them, even Alibaba. The tide has come out, we found out plenty of these companies were swimming naked, who’s to say there aren’t others?

This uncertainty has led me to make a big change to my portfolio: selling my entire stake in JD.com. Here are the main reasons why I chose to do so.

The First Rule of Investing

Is to not lose money. And boy did Luckin bagholders screw the pooch on that one. When a company admits to committing fraud, you can expect at best to have 75% of the equity wiped out. This can be detrimental to portfolio returns and must be avoided at all costs.

Do I think JD.com is a fraud? If I had to choose an answer, I’d say no. There’s no evidence saying so. But do I know for sure that they aren’t a fraud? Of course not. Which means there is a small chance of a giant loss.

Don’t get me wrong, I’m a big fan of what JD.com has done, and think if they have the right macro conditions and are totally legit that they can be one of the largest retailers in the world. I’m just not comfortable investing in them at the moment.

And speaking of macro conditions…

The State of the Chinese Economy is Worrisome

People have been saying the Chinese economy has been a house of cards for years. Maybe I’m just paying too much attention to Jim Chanos and reading too much Peter Zeihan, but I kind-of think all these so-called fear-mongers (who are typically intelligent, by the way) might be right.

Here’s why I think that. One, almost half-a-million Chinese companies closed their doors in the first quarter. Two, the CCP covered up the extent of the coronavirus outbreak, which other countries will not take sitting down. Three, China’s debt is 310% of its GDP (most economies suffer defaults if they hit these levels) while tax revenue fell 11.2% this winter. I would not call this a stable situation.

Let’s peer into the future. If China goes into a depression because one of its precarious legs gets broken, domestic demand for consumer products likely plummets. And where does JD.com’s revenue come from? That’s right, consumer products.

Not Enough Reward

When investing in emerging markets you should always expect a higher upside on stocks. Why? Because you are taking on more risk.

I used to think JD.com had enough upside to offset the risk of investing in a Chinese company. But with the recent allegations and fact that the stock’s valuation has almost doubled within a year, I don’t believe that anymore.

Could JD.com still become a $250 billion company as I thought in the fall? Absolutely. There’s just less of a chance now. It’s never wise to be stubborn when the facts about your investment change. I believe that is happening right now.

Better Opportunities in the States

As I write this the U.S. market has roared back 25% off the lows, which makes valuations more expensive, but I still see a lot of opportunities for long-term investors among individual tickers. More so than across the Pacific.

Companies like Altria Group, Stitch Fix, Match, Revolve Group, and Roku, just to name a few, are all trading at huge discounts to their long-term value. I don’t have much capital to work with, and I like to run a concentrated portfolio, so I tend to be really picky about who makes the cut. JD.com is not making it at the moment.

The Tide is Coming Out in the United States

Don’t think U.S. companies are immune from scandal either. In every recession, it is guaranteed that:

  1. Debt-ridden companies will go bankrupt (already in the process of happening with airlines/cruises)

  2. Frauds will be uncovered (cough, cough, Tesla)

  3. Ponzi schemes will unwind

We’re barely one month into a likely six-month crisis/recession (at least), so don’t think all the dominoes will fall at once. Just make sure to own companies with stable balance sheets and high-integrity executives. Oh, and don’t give your money, in any circumstance, to shady people or fear mongers.

Financial crises like this happen. Maybe not ever with this velocity, but they do happen. As an individual investor, all you can do is make sure you come out the other side intact.

Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.


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