Why are Chinese concept stocks always related to social media?

There are quite a few "cigarette butt stocks" among Chinese concept internet companies. However, companies like Xunlei, Qudian, and Mogujie becoming cigarette butt stocks is somewhat understandable: their businesses have lost actual competitiveness. But for companies like Weibo, Momo, and YY, which are still leaders in their respective fields, to become "cigarette butt stocks" while being "young and strong" raises doubts about the business model of social networking.

Cigarette Butt Stock Empire

If an institution were to launch an ETF called "Quality Chinese Concept Internet Cigarette Butts," it is likely that nearly half of the contents would be social companies.

What is a cigarette butt stock? Although there is no clear definition, it is generally believed that when a listed company's market value falls below its cash, i.e., the price-to-book ratio (PB) is less than 1, it can be considered a cigarette butt stock. The term "cigarette butt stock" became widely known due to Warren Buffett, who described it as: "Picking up a cigarette butt on the street, short enough to take only one more puff, and discovering all the profits from that last puff."

Setting aside whether profits can be discovered, social companies indeed resemble cigarette butt stocks in being "short."

Hello Group was once thought to be building the largest stranger social empire in the country. This vision has indeed become a reality; today, Hello Group is the Tencent of stranger social networking, with monthly active users surpassing 100 million years ago. Although there has been some decline since then, Hello Group, which owns Momo and Tantan, remains the undisputed leader in stranger social networking. When describing the power of communications chip giant Broadcom, people often use the phrase, "X% of global communication signals will at least pass through a Broadcom chip." If this phrase were applied to Hello Group, it would be, "X% of genetic information transmission in the country will at least pass through a Hello Group software."

If Momo's strength were placed ten years ago, people would not doubt it would become a huge business empire. But in reality, it has become a huge "cigarette butt."

Since 2022, Hello Group's stock price has fluctuated but has remained around $1 billion, while Hello Group's net cash on hand is about $1.4 billion. Currently, the TTM price-to-earnings ratio is only about 7 times.

Hello Group is still very profitable. The financial report released on June 5 showed that Hello Group's revenue was 2.52 billion yuan, with profits exceeding 400 million yuan. For the entire year of 2024, Hello Group's adjusted net profit is still expected to be 1.233 billion yuan, with a net profit margin above 10% and a gross profit margin exceeding 30%. Although revenue is declining, Hello Group remains a cash printing machine rather than a money-burning machine.

After the financial report was released, Hello Group's stock closed up 13% in the U.S. market. However, despite this significant increase, its market value is still only $1.134 billion—still a cigarette butt.

Hello Group not only makes money but also provides excess returns to shareholders. Throughout 2024, Hello Group repurchased 13% of its shares, while Tencent, known for its large repurchase amounts, only repurchased about 3% of its shares (300 million shares, totaling HKD 112 billion) in 2024.

Moreover, Hello Group also had a dividend of $0.54 per share this year, which, based on the price at that time, corresponds to a dividend yield of about 10%

Caption: Hello Group's dividend payout has always been substantial.

—— If Buffett were to return to his younger days, this would be the type of company he would invest in.

Hello Group's stock price is low enough, but in terms of PB, the former parent company of YY, Huanyou Group, is the shortest "cigarette butt." After selling YY to Baidu for $2.1 billion, Huanyou Group's total market capitalization is only about $2.5 billion. Due to a large amount of cash on hand, Huanyou's net assets are already more than twice its market value.

Caption: With such a gap between net assets and stock price, is the business still important?

Its shareholder returns are also quite generous. In 2024, before the delivery of YY, Huanyou Group repurchased 15.1% of its total shares. In addition, there is a quarterly dividend of $0.93 per share.

Although the shareholder return rate is not as high as that of Hello Group and YY, Weibo's business competitiveness is much stronger. In the recently released Q1 2025 financial report, Weibo's net income reached 2.883 billion yuan ($396.9 million), remaining flat year-on-year, and if calculated at a fixed exchange rate, it even grew by 1% year-on-year. The adjusted operating profit reached 943 million yuan, with a very high profit margin. In terms of core user metrics, Weibo's monthly active users are 591 million, and daily active users are 261 million, which have remained stable.

Strong profitability has led to Weibo's cash pile. As of 2024, Weibo's total cash, cash equivalents, and short-term investments amount to $2.4 billion.

However, this does not prevent Weibo from being considered a cigarette butt stock.

As of the close on June 6, Weibo's market capitalization was only $2.36 billion—less than last year's cash on hand. Compared to net assets, Weibo's stock price of less than $10 has a net asset value of $14.02 per share.

Weibo is not stingy either; starting in 2023, Weibo has been conducting a large annual dividend of over $0.8 per share, resulting in a dividend yield of over 8% based on the current stock price.

These three are narrowly defined "social companies." If we broaden the scope of social companies to include social media, several more names should be added to this list.

Zhihu is also a company with a strong social flavor. Many years ago, a user stated that Zhihu's surface is knowledge, but its essence is social interaction, a response that was liked by the founder, Zhou Yuan. With the founder's acknowledgment, Zhihu can indeed be considered half a social company.

However, its stock price has already fallen below the income tax paid by shareholders at the time of the stock distribution. After the release of the Q1 2025 financial report, Zhihu has achieved profitability for two consecutive quarters. Yet, it is still regarded as a cigarette butt stock; currently, Zhihu's total market capitalization is only about $350 million (approximately 2.5 billion yuan), while Zhihu's cash on hand is close to 4 billion yuan, with a very low debt ratio

This cash comes from the market's previous optimism about Zhihu—despite years of losses, the amount raised back then is still worth more than today's market value.

Reverse Network Effect

Cigarette butts are not limited to any industry, but they always cluster in certain sectors.

For example, in the 1960s, the stocks of many textile factories in the United States plummeted to rock-bottom prices, and Buffett purchased one of them—Berkshire Hathaway. This textile business eventually went bankrupt, but Buffett used its "shell" as the parent company of his business empire, leading to the current trillion-dollar market value of BRK.

Behind Buffett's cigarette butt activities is a larger backdrop of industrial migration: the outsourcing of manufacturing, which has extremely long-term effects. Even manufacturing empires like GE (General Electric) saw their stock prices drop to cigarette butt levels. As for the automotive industry, almost all except Ford have faced bankruptcy.

During the 2008 financial crisis, highly leveraged banks and financial institutions faced massive failures: the stock prices of Bank of America, Wells Fargo, and Goldman Sachs all plummeted, with Goldman Sachs' market value even experiencing multiple halving. Buffett entered the market at the right time and completed his harvest. His investments in these three financial institutions during the financial crisis solidified Buffett's legendary status.

Caption: The glamorous Goldman Sachs once also fell to rock-bottom prices.

After 2022, many Chinese concept internet companies saw their stock prices plummet, with many falling below their net cash value, becoming cigarette butt stocks.

The "clustering effect" is still evident—social platforms are particularly prominent. Unlike companies like Mogujie, Xunlei, Sohu, and Cheetah, which have lost their business competitiveness, many of these platforms still retain their competitive edge. Hello Group is the leader in stranger social networking, while similar product Discord is thriving overseas. Zhihu is the largest Q&A community in China. Weibo is the largest image and text social media platform in the country.

This is certainly not a coincidence.

After meeting Munger, Buffett gradually abandoned the cigarette butt investment strategy. After 2010, "China's Buffett," Duan Yongping, made a similar choice.

Their reasons for abandoning it are the same: business model. Duan Yongping stated that while he does not know the precise definition of a cigarette butt, he can be sure that the business model of cigarette butt companies is poor. After all, companies with good business models can always stand firm in various crises. Objective factors certainly exist, but the root of the crisis lies in the inherent flaws of the company's business model.

Looking back at the cigarette butt stocks Buffett has picked, they almost all share several shortcomings: low profit margins, high leverage, and heavy assets.

In a rising period, these issues can be masked—just as real estate companies once enjoyed unlimited glory, with several leaders ranking high on the rich list. But ultimately, the profit margins in real estate are not high, the assets are extremely heavy, and the leverage is terrifying, making it hard to consider it a good business. As for the bank cigarette butt stocks Buffett invested in in 2008, while they appeared glamorous, their absolute profit margins were not high, and the extremely high leverage made their risk resistance very poor However, social companies do not conform to these shortcomings.

Hello Group's gross margin is close to 40%, Huanyuq Group's gross margin is similar to Hello Group, Zhihu's gross margin exceeds 60%, and Weibo's gross margin is as high as 80%. As platform-type enterprises, they do not have large amounts of infrastructure construction, R&D expenses, capital expenditures, or operational leverage. On the contrary, strong network effects give them a moat when facing competition.

High gross margins, light assets, and strong network effects make social platforms an extremely counterintuitive existence, a brand new type of business.

They do not have the heavy asset flaws similar to GE, but the existence of network effects also brings about a reverse "curse": the general definition of network effects is: the more people use it, the better it works. However, during a downturn, it turns into: the fewer people use it, the harder it is to use.

This is exactly the trouble that Momo has faced in recent years, as the rise of Soul, Zuiyou, Yidui, and various new dating apps has made its leading position no longer as solid as before.

The decline of most companies is slow, and there may be occasional growth in the decline, such as Toyota in the manufacturing industry, which has already fallen into a slowdown due to the rise of new energy vehicles, but its revenue is still growing slowly in 2024.

Due to the existence of "reverse network effects," the decline in users of social software can sometimes be extremely exaggerated, and once a social platform begins to enter a downward cycle, it is difficult for revenue to rebound intermittently: compared to the peak in 2018, Tantan's monthly active users have declined by more than 60%. Momo's paying users have also declined by about 40% over the past three years. Ten years ago, social platforms were known for their explosive growth rates, but now they are also beginning to show their "proud" decline rates.

Caption: According to data from Analysys Qianfan, Tantan's monthly active users have significantly declined.

——The long-term decline is also the most direct reason for them becoming a "cigarette butt." Their stock prices have even fallen below net assets, but the value trap still makes investors hesitant. After all, once trapped in continuous losses, no amount of cash is just a temporary paper number.

A bigger flaw is that in the most direct income segment related to money, some social cigarette butts have a terrible monetization efficiency that traditional companies find hard to compare.

Since basic functions are free, social platforms often need to sell some very inefficient value-added services, but most consumers do not buy into it. As the leading stranger social platform in China, Momo's latest paying users are only 4.2 million. Momo does not disclose its monthly active users now, but according to Analysys Qianfan's data, its monthly active users exceed 40 million.

——This means that most users on the platform cannot generate any revenue.

Soul, a social software with a simpler business model, has even worse monetization capabilities: the prospectus previously submitted by Soul showed that with nearly 30 million monthly active users, its revenue in 2022 was only 1.671 billion yuan, and it has been in continuous losses. The annual revenue generated per monthly active user is only about 55 yuan Momo and Soul still have some direct consumption value-added services, while platforms like Zhihu, Hupu, and Tianya, which are community-based, often rely on advertising for monetization. However, the efficiency of advertising varies; efficiency machines like Google, Meta, and Douyin are hard to come by, and most social platforms lack good advertising placements and have limited conversion efficiency. Zhihu's revenue per monthly active user in 2024 is only about 45 yuan. In its ten years of commercialization, Zhihu has tried no less than five monetization models, including but not limited to paid knowledge, paid novels, vocational education, advertising, and content-driven sales.

Switching perspectives to American social networks, the issue is the same. Reddit boasts a large number of young users, with monthly active users continuously rising and a very high gross margin, yet it has not made a profit for years. It wasn't until the third quarter of 2024, after 20 years of establishment, that it turned a profit for the first time. The reason for Reddit's profitability is simple: the revenue is too low. In the prospectus released at the beginning of 2024, Reddit generated only about $10 per user per year. Marginal utility is the advantage of internet platforms, but many social platforms do not even have a basic scale of revenue.

Among social platforms, companies like META that make money efficiently are more of an exception. More often, inefficiency is synonymous with social.

Insufficient Monetization Efficiency

Some shortcomings of social platforms cannot be escaped even by the winners.

At the end of 2023, multiple sources disclosed that ByteDance's revenue surpassed Tencent's. Behind this phenomenon is WeChat's awkward position: with 1.4 billion users and a business scope spanning social, content, local life, and finance, it should be the world's number one internet app, yet its ability to generate revenue is inferior to Douyin. Even when adding the highly profitable gaming and social entertainment sectors, it still cannot outperform an app with fewer users.

From a product structure perspective, WeChat's monetization is not as efficient as Tencent's own games. After all, its core function is chatting, which is an extremely difficult feature to monetize. WeChat is already a result of extraordinary transformation; as a comparable product, a chat tool like WhatsApp has almost no commercial value and is more of a strategic product.

WeChat's monetization largely relies on innovative features beyond its main function: Video Accounts, Service Accounts, Search, Mini Programs, and more imaginative AI capabilities. However, as a chat software, the degree of integration of many services with WeChat depends entirely on Tencent's exploration.

And although Douyin also has certain social attributes, its monetization efficiency has completely surpassed that of traditional social platforms. The content format that is highly compatible with advertising and a rich commercial ecosystem have made Douyin an efficiency machine that "earns money every second."

However, WeChat has now become Tencent's primary growth driver, and in Tencent's recent quarterly reports, WeChat's name appears in almost every growth driver.

Yet in the first quarter financial report, the marketing service revenue led by WeChat still only accounted for 17.6% of Tencent's total revenue. Of course, aside from marketing services, WeChat's live-streaming e-commerce technical service fees, WeChat payment transaction fees, and other income are categorized under financial and enterprise services. Additionally, some of WeChat's mini-game revenue is also classified under value-added services, but specific figures have not been disclosed in the financial report WeChat's monetization is no longer as restrained as it used to be; advertisements in Moments are increasing, and the commercialization process of video accounts, search, and even e-commerce is accelerating. In this process, Tencent will explore where the ceiling of WeChat's commercialization lies.

Xiaohongshu (Little Red Book) is a direct factor in Weibo becoming a penny stock. This platform, with a more innovative model and unique tone, is gradually squeezing Weibo's living space.

However, even for the most popular Xiaohongshu, the explosive growth in users has not changed its losses. It wasn't until 2023, ten years after its establishment, that Xiaohongshu finally achieved profitability for the first time.

Since 2022, Xiaohongshu's commercialization efforts have become increasingly intensive. While maintaining its content capabilities, it has continuously increased its investment in the e-commerce sector, becoming half an e-commerce platform. The returns are also evident; according to foreign media reports, Xiaohongshu's revenue in the first quarter of 2024 exceeded $1 billion, with a net profit of $200 million, a fourfold year-on-year increase.

In social media, this is a high-quality monetization efficiency. However, compared to real e-commerce platforms, its monetization efficiency is still lacking: during the same period, the "outdated" e-commerce platform Vipshop still had a net profit of around $320 million (2.3 billion RMB) — according to Aurora data, Xiaohongshu's monthly active users reached 330 million in November 2024, while Vipshop's financial report disclosed 41.3 million active consumers, indicating a user gap of about 8 times. (Vipshop did not specify whether active consumers are monthly or quarterly active users.)

Although Xiaohongshu has a strong commercial gene, it is not fundamentally an e-commerce platform. The conversion process between content and e-commerce inevitably leads to efficiency losses, much like the energy loss between steam engines and internal combustion engines. Perhaps because of this, Xiaohongshu continues to waver between internal e-commerce and external advertising links — the most recent wavering occurred on May 7, when Taobao Tmall and Xiaohongshu officially announced a strategic partnership, launching the "Red Cat Plan," which supports one-click redirection of Xiaohongshu's advertising links to Taobao's shopping platform. At the same time, Xiaohongshu also added a "Friendly Market" tab on personal homepages as an e-commerce entry point.

Of course, how to maintain profit and revenue growth is a concern, but it is, after all, a winner's worry. For those social platforms that have already become penny stocks, growth has become a luxury. Investors' attention to their businesses is decreasing, and their mindset is akin to that of Buffett picking up cigarette butts: being able to smoke a few more puffs is their "main task."

Author of this article: Yang Zhichao, Source: 36Kr, Original title: "Why Are Chinese Concept Penny Stocks Always Social Media?" Risk Warning and Disclaimer

The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investment based on this is at one's own risk