(Bloomberg Businessweek) -- Iflytek Co., a Chinese developer of speech-recognition software, has consistently failed to meet analysts’ profit estimates. And yet it’s one of the hottest stocks in China, gaining 117 percent this year as of Dec. 18, thanks to the latest investment craze sweeping the country’s $7.5 trillion equity market: artificial intelligence.
Iflytek and other AI-related companies are dominating gains among large-cap Chinese stocks. The buying frenzy has added $61 billion of market value to China’s five most popular AI plays, vaulting some into the ranks of the world’s most actively traded securities. BOE Technology Group Co., a Beijing-based maker of LCD panels that’s developing a system to help drivers avoid traffic accidents, had the equivalent of $2.5 billion in shares change hands on a single day in November, outtrading Wal-Mart Stores Inc. and AT&T Inc. combined.
“Retail investors in particular are crazy about companies that have an AI story,” says Zhang Gang, a Shanghai-based strategist at Central China Securities. A growing number of analysts and fund managers warn that the rally has gone too far, too fast. They say many AI technologies are unlikely to prove profitable, and even those that do could take years to make significant contributions to companies’ bottom lines. “Almost every company is standing at the starting line,” says Wang Menghai, a Shanghai-based money manager at Fullgoal Fund Management Co. “The short-term increases for these stocks are a bit too much.”
Iflytek, which has trailed analysts’ net income projections every year since its stock began trading in 2008, has a market value of $12.3 billion. It trades at 109 times projected 2018 earnings, compared with an average of 13 for China’s CSI 300 Index and 25 for the Indxx Global Robotics & Artificial Intelligence Thematic Index, which tracks companies around the world.
Individual investors—an important force in China—pay little attention to metrics such as earnings, according to Kenny Wen, a strategist at Everbright Sun Hung Kai Co. in Hong Kong. Some are using borrowed money to amplify their wagers on stocks including Iflytek’s and BOE Technology’s, says Xia Yu, a Beijing-based analyst at ICBC Credit Suisse Asset Management Co.
Xi Jinping’s government is adding fuel to the frenzy. Authorities have announced ambitious plans to make the country a world leader in AI. China’s cabinet made public in July that it plans to boost the output of AI-related industries to 10 trillion yuan ($1.5 trillion) by 2030, a figure that amounts to more than a 10th of the nation’s 2016 gross domestic product. Last month authorities identified Iflytek, Tencent Holdings, Alibaba Group Holding, and Baidu as leaders in AI technology. Government favor is often viewed by domestic stock traders as a green light to buy.
Fans of China’s AI stocks say the high price-earnings ratios are justified by the companies’ long-term potential. Because many AI-related businesses are still so new, investors should focus more on sales growth, says Sam Kuo, manager of the UPAMC Global Innovative Tech Fund in Taipei. Iflytek made a similar point in August, noting in comments published online that Amazon.com Inc. has become one of the world’s most valuable companies despite reporting little or no profit for years. Iflytek, based in Hefei, Anhui province’s capital, didn’t respond to requests for comment.
Similar bouts of stock market euphoria in China, including those fueled by government policies, haven’t ended well. Shares of Shanghai-based companies soared in 2013 after policymakers announced plans for a free-trade zone in the city. The rally fizzled after a few months as investors realized it could take years for companies to profit from the zone’s relaxed capital controls.
One risk for AI-related stocks is that the field is becoming crowded, according to Joel Ying, a Nomura Holdings Inc. analyst in Hong Kong. While Iflytek’s real-time translation software helped it earn the title of China’s “smartest” company in the 2017 MIT Technology Review, it faces competitive threats at home and abroad. Chinese giants including Tencent and Alibaba are investing heavily in AI, while international companies including Google parent Alphabet Inc. have been developing the technology for years. “I’d be cautious,” says David Dai, an analyst at Sanford C. Bernstein in Hong Kong. “AI products take a long time to monetize, and there is significant investment involved, so the earnings might not grow as fast as people expect.”
To contact the authors of this story: Jeanny Yu in Hong Kong at jyu107@bloomberg.net, Cindy Wang in Taipei at hwang61@bloomberg.net.
To contact the editors responsible for this story: Pat Regnier at pregnier3@bloomberg.net, Richard Frost Michael Patterson
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