Why Tencent, Tencent Music Entertainment, and iQiyi All Soared Today

Shares of Chinese consumer tech stocks Tencent (OTC: TCEHY), Tencent Music Entertainment (NYSE: TME), and iQiyi (NASDAQ: IQ) were rallying on Tuesday, up 6.5%, 15.7%, and 11.7%, respectively, as of 1:15 p.m. ET.

On Tuesday, the Chinese government and central bank unveiled the country's biggest stimulus measures since the pandemic. Chinese stocks have been trading cheaply as the country has been experiencing economic weakness for some time, and these consumer-focused stocks were among those that soared in response to Beijing's latest plan to address that weakness.

China cuts interest rates and lowers barriers to homebuying

The People's Bank of China announced a slew of stimulus measures. These include lowering a variety of interest rates, such as the medium-term lending rate, prime rates, deposit rates, and the reverse repo rate, which is what banks receive for parking their funds at the central bank. In addition, China lowered the amount of reserves its banks need to keep on their balance sheets, freeing up more funds for lending.

China's real estate market is particularly troubled, so the government lowered mortgage rates and cut the standard down payment on houses to 15% from the previous 25%. The property crisis in China is one of the main reasons for the broader economic slowdown, as 70% of China's household savings are invested in real estate. So the property crisis has caused China's consumers to pull back on spending, with deflationary forces and job losses taking root.

There is an ongoing debate as to whether these measures will be enough. While they may entice some consumers to buy homes and banks to lend more, if consumers are still hesitant and don't take on more debt to buy things, these measures won't have that much of an effect. Detractors are calling for additional fiscal stimulus measures that would either directly fund jobs or put money directly into the hands of consumers.

Still, the measures were actually more than analysts had expected, given China's muted response to its multiyear economic crisis. Thus, they spurred hopes that more actions to support the economy may be coming, since the government has clearly signaled that it understands the need for more stimulus.

Meanwhile, Chinese stocks had gotten so cheap relative to their U.S. counterparts that it's not surprising the news caused a rally. Tencent, the most dominant and high-quality tech giant in China, trades at just 14 times forward earnings estimates. Tencent Music, a subsidiary of Tencent in which Tencent owns a 52.5% stake, trades at 13 times forward earnings despite having a huge amount of cash on its balance sheet and no debt. And streaming video giant iQiyi, which is 46% owned by search giant Baidu, trades at just 6.7 times forward earnings estimates as its revenues are declining.

Chinese stocks have high upside potential, but high risks

With their stock valuations so low and the government in Beijing taking more measures to stabilize the economy, Chinese tech and consumer companies like these three have huge amounts of upside potential, even after Tuesday's moves.

Still, investors should keep in mind the very real risks. These include a Chinese government that is engaging in saber-rattling regarding a potential war with Taiwan, that took heavy-handed measures against the country's top technology companies, and that implemented a restrictive and extended "zero-COVID" policy instead of buying U.S.-made vaccines -- a policy that stalled its economy for a long period well after other advanced countries had largely emerged from pandemic restrictions.

With all that in mind, there are certainly reasons for many investors to view these companies as uninvestable at the moment. However, if China returns to more capitalist-friendly policies, implements more stimulus, and backs down from its Taiwan rhetoric while courting foreign companies, China's cheap stocks could handily outperform.

However, those are all fairly big "ifs" today, even after Tuesday's positive news.

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Billy Duberstein and/or his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Baidu and Tencent. The Motley Fool recommends iQIYI. The Motley Fool has a disclosure policy.