OOver the past two decades, many investors have bought Chinese tech stocks because they seemed to offer more growth potential than their US counterparts. On the surface, the comparisons seemed straightforward.

Baidu (NASDAQ: BIDU), which has China’s largest search engine, is often compared to AlphabetGoogle. Ali Baba (NYSE: BABA), China’s leading e-commerce and cloud platform company, looks similar to Amazon.

But if we dig deeper, we’ll spot significant differences between Chinese and US tech companies. Let’s discuss six often overlooked facts investors should consider before buying Chinese tech stocks.

Image source: Getty Images.

1. Chinese tech stocks are moving from imitators to innovators

Many of China’s biggest tech companies started out by imitating foreign companies. Tencentof (OTC: TCEHY) The first major product of the late 1990s was QICQ, a clone of the popular ICQ messaging platform.

After being threatened with legal action, Tencent renamed QICQ to QQ and expanded it to an online platform for social games, music, movies, shopping, microblogging, and group chats. QQ’s growth paved the way for the launch of WeChat, the mobile messaging platform that now serves more than 1.2 billion monthly active users.

WeChat now locks down users with millions of mini-programs, which allow them to pay bills, buy things, run errands, play games and more without ever leaving the app. This development, which can be spotted in many other Chinese tech companies, shows how imitators have evolved into innovators.

2. Chinese tech stocks tend to go public in the US first

Many Chinese tech companies, including Baidu and Alibaba, went public in the United States long before they launched secondary listings in Hong Kong. They did this for two reasons.

First, Chinese stock exchanges had stricter listing requirements and longer waiting periods than US stock exchanges. Second, the New York Stock Exchange and Nasdaq Stock Market gave them access to much more capital than domestic exchanges.

3. Many Chinese tech stocks have an opaque property

The Chinese government does not allow foreign investors to hold stakes in its technology companies. But SINA, the first major Chinese tech company to go public in the United States, circumvented the rule by creating the VIE (Variable Interest Entity) structure, which creates a holding company in a third country like the Cayman Islands.

VIE, which was still controlled by Chinese citizens, held shares of the underlying company in China. When SINA went public in New York in 2000, it only listed VIE shares – which prevented foreign investors from taking control of the current company.

Other companies bought small publicly traded companies in the United States and went public through reverse mergers. This approach, which the SEC did not aggressively monitor at the time, allowed many fraudulent companies with false financial information to sneak onto U.S. exchanges.

4. US investors may be affected by privatization deals

Many Chinese companies that go public in the United States are still completely controlled by their founders through opaque ownership structures. As a result, these founders may abruptly privatize their companies after raising funds on the US stock exchanges and then relist them on the Chinese stock exchanges to raise even more money on new IPOs.

Image source: Getty Images.

US investors have no way of blocking these trades, often forcing them to sell their stocks at large losses. For example, SINA went private earlier this year after being acquired by New Wave Holdings, a company directly controlled by SINA CEO Charles Chao.

The $ 2.6 billion offering valued SINA at just over once its annual revenue and placed virtually no value on its controlling stake in Weibo (NASDAQ: WB) – which currently has an enterprise value of $ 10 billion.

But that’s just the tip of the iceberg. Many other Chinese tech companies have gone private under similar deals and let US investors hold the bag.

5. Chinese tech stocks are under regulatory pressure from all sides

Many Chinese tech stocks have underperformed the market this year for two reasons. First, they fell out of favor as concerns about inflation and rising bond yields triggered a rotation from growth stocks to value stocks.

Second, regulators in China and the United States are pressing these big companies. China fined Alibaba a record $ 2.8 billion earlier this year after its antitrust investigation, and slapped Tencent, Baidu and other tech companies with additional fines for unapproved acquisitions. Chinese regulators are also constantly monitoring these technology platforms for “inappropriate” content.

Meanwhile, US regulators recently approved a law that will remove foreign companies from US stock exchanges if they do not comply with stricter auditing standards within three years. They will also have to prove that they are not controlled by foreign governments – which could be difficult as the Chinese government tightens its grip on the country’s biggest tech companies.

6. Despite the problems, some Chinese tech stocks are still doing good business

After reading these five points, investors might avoid all Chinese tech stocks. It might be a prudent move, but investors who can handle short-term volatility can still find good deals.

For example, JD.com (NASDAQ: JD), China’s second-largest e-commerce company, continues to shoot all cylinders – but its shares are trading at just 28 times forecast earnings and less than once this year’s sales.

Therefore, I don’t think investors should completely avoid all Chinese tech stocks. However, I think they should read the fine print carefully instead of blindly chasing the fastest growing names in the industry.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of the board of directors of The Motley Fool. Suzanne Frey, executive at Alphabet, is a member of the board of directors of The Motley Fool. Leo Sun owns shares in Amazon, Baidu, and JD.com. The Motley Fool owns shares and recommends Alibaba Group Holding Ltd., Alphabet (A shares), Alphabet (C shares), Amazon, Baidu, JD.com and Tencent Holdings. The Motley Fool recommends the following options: January 2022 long calls at $ 1,920 on Amazon and January 2022 short calls at $ 1,940 on Amazon. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.