China's Tech Rally: Can Valuation Discounts and Policy Gains Sustain the Momentum?

The Hang Seng Tech Index has surged nearly 30% year-to-date in 2025, fueled by a policy "reset" and AI breakthroughs. Yet, skeptics warn of overbought technicals and lingering risks. Is this rally sustainable, or is a correction looming? Let's dissect the valuation disparities, earnings trends, and policy shifts shaping the prospects of Tencent, Alibaba, and Xiaomi.

Valuation Disparities: A Discounted Bargain or a Hidden Trap?

Chinese tech stocks trade at historically low valuations compared to global peers. Take a closer look at the key metrics:

Tencent's trailing P/E of 21.09x remains below Microsoft's 31.30x and Amazon's 37.6x, despite its dominance in gaming and AI-driven social platforms. Alibaba's P/E of 11.07x is even more compelling, reflecting market skepticism about China's tech sector. Meanwhile, Xiaomi's EV/EBITDA of 4.92x is a fraction of Samsung's 9.8x, signaling undervaluation in hardware and IoT.

However, low valuations alone don't guarantee upside. Investors must assess whether earnings can justify these discounts.

Earnings Trends: Growth vs. Structural Risks

Recent quarters have highlighted divergent paths among the trio:

1. Tencent:
2. Q1 2025 Revenue: Rose 13% YoY to HK$151.2 billion, driven by gaming (18% growth in international markets) and cloud services.
3. Margin Pressure: AI investments (e.g., DeepSeek partnerships) may delay near-term margin expansion, but its 31.87% operating margin remains robust.

4. Catalyst: Share buybacks totaling HK$80 billion could boost shareholder returns.

5. Alibaba:

6. Cloud & AI Momentum: Cloud Intelligence Group revenue jumped 18% YoY, with AI products like Qwen3 achieving triple-digit sales growth.
7. Profitability: Adjusted EBITDA surged 36% YoY to RMB32.6 billion, thanks to cost discipline and AI efficiency gains.

8. Ant IPO: A potential $8–24 billion Hong Kong listing could add 15–40% to Alibaba's enterprise value, making it a key catalyst.

9. Xiaomi:

10. Margin Turnaround: Gross margins improved to 15.2% in Q1 2025, up from 12.3% in 2023, as it shifts focus to premium smartphones and IoT devices.
11. Geopolitical Resilience: International expansion (e.g., Southeast Asia) offset domestic weakness, with overseas revenue up 22% YoY.

Policy Shifts: A Tailwind or Temporary Boost?

The February 2025 meeting between President Xi and tech leaders marked a policy pivot toward innovation over regulation. Key outcomes include:

• AI-Friendly Frameworks:
• Reduced regulatory hurdles for data usage in AI development.

• DeepSeek's R1 model (cost-effective, chip-agnostic) has become a linchpin for enterprise adoption.

• Trade Deal Optimism:

• U.S.-China tariffs on tech components dropped from 145% to 30%, easing costs for Alibaba's logistics and Xiaomi's hardware divisions.

• Capital Allocation:

• Beijing's National Venture Capital Guidance Fund is funding AI and robotics, benefiting Alibaba's cloud and Xiaomi's IoT initiatives.

These shifts have fueled optimism, but risks persist. U.S. semiconductor export controls and SMIC's chip shortages remain a drag on AI progress.

Technical & Market Signals: Overbought or Overlooked?

• Capital Economics' Bullish Case:
• Argues that valuation discounts (e.g., Alibaba's 11.07x P/E vs. Amazon's 37.6x) and AI-driven efficiency justify further gains.

• Highlights the rotation into AI infrastructure stocks in February 2025, which outperformed speculative metaverse plays.

• Bearish Concerns:

• Overbought Technicals: The Hang Seng Tech Index's RSI hit 70+, signaling short-term exhaustion.
• Historical Precedent: Bank of America warns of parallels to the 2015 rally, which ended in a correction.

Upcoming Earnings: The Crucible for Momentum

The next critical test lies in Q2 2025 earnings, due in late July. Key metrics to watch:

• Alibaba's Cloud & AI Revenues: Must sustain 15–20% YoY growth to validate its valuation upside.
• Tencent's Margin Resilience: AI costs should not erode its 30%+ operating margins.
• Xiaomi's Profitability: Gross margins need to hold above 15% as it competes in price-sensitive markets.

Failure to meet these benchmarks could trigger a rotation out of overbought names.

Investment Recommendations: Capitalize or Cautious?

Bull Case (Buy):
- Alibaba: Its 11.07x P/E, fortress balance sheet ($51.9 billion in cash), and Ant IPO catalyst make it a compelling value play.
- Tencent: Diversified revenue streams (gaming, fintech, cloud) and a 3.01% total shareholder yield justify its premium.

Bear Case (Proceed with Caution):
- Xiaomi: While its EV/EBITDA of 4.92x is undervalued, semiconductor shortages and weak rural demand pose execution risks.
- Technical Overhang: Short-term traders may sell into strength if the Hang Seng Tech Index breaches resistance at 5,000 points.

Conclusion: A Selective Rally Ahead

China's tech sector is at a crossroads. Valuation discounts and policy tailwinds argue for sustained momentum, but execution on AI earnings and geopolitical risks will determine the path. Investors should:
1. Focus on Quality: Prioritize Alibaba and Tencent for their AI-driven growth and balance sheets.
2. Monitor Earnings: Use Q2 results as a filter to separate winners from pretenders.
3. Avoid Overbought Speculation: Rotate out of names lacking clear AI monetization or margin visibility.

The rally isn't over—yet. But investors must pick their spots carefully.

Final Verdict: Alibaba (9988.HK) and Tencent (0700.HK) offer the best risk-reward trade-offs. Xiaomi (1810.HK) is a speculative bet requiring patience. Stay cautious on technical overbought signals until earnings confirm momentum.