CITIC SEC: In 2026, Internet sector AI narrative strengthening, vertical segment track presents structural opportunities.

CITIC SEC released a research report stating that the internet sector is expected to experience a volatile upward trend in 2025 amid external disturbances, driven mainly by AI-driven value reevaluation and improved liquidity. Looking ahead to 2026, AI is expected to remain a core catalyst for the sector's valuation increase, with a focus on model iteration, application implementation, and performance realization leading to narrative reinforcement. Companies with lower short-term AI relevance should focus on performance visibility and valuation cost-effectiveness as core stock selection criteria. It is recommended to pay attention to leading companies in stable competitive landscapes, strong performance resilience, high-growth sectors driven by supply innovation, and undervalued absolute return targets. CITIC SEC's main points are as follows: Review of 2025: Valuation increase driven by AI and loose liquidity. In 2024/2025, the Hang Seng Tech Index saw a year-on-year increase of 19%/23%, while EPS expectations were +27%/-10% YoY (Bloomberg consensus). In 2025, the Chinese internet sector experienced an upward trend amid external disturbances, primarily benefiting from the AI-driven valuation recovery supported by liquidity. As of December 24, 2025, the Hang Seng Tech Index NTM PE stood at 19.3x, which is at the 42.4th percentile over the past 5 years. Individual stocks such as POP MART (09992), Alibaba (09988), NETEASE MUSIC (09899), Kuaishou, NetEase, Tencent Music, BOSS Zhipin, and Tencent (00700) significantly outperformed the sector by returns of 126%/81%/63%/62%/59%/58%/54%/49% respectively as of December 22. This was mainly due to the valuation recovery driven by the AI industry trend and the performance and valuation of emotion-related assets. Looking ahead to 2026, the implementation of AI applications is expected to further drive valuation improvement. For companies with lower short-term AI relevance, performance visibility and valuation cost-effectiveness will be the core drivers of stock price increase. AI: Continued development of AI with expected IPOs and application implementations to drive value reevaluation. Model capabilities: Accelerating domestic model development, with full modal, long-context, and Agentic capabilities becoming important directions for iteration. In 2025, large domestic models led by DeepSeek caught up with overseas models in limited algorithm resources through algorithm innovation and AI infrastructural optimization. Models such as SuperClue, DeepSeek, Alibaba's Tongyixin Qianwen, and Bytepack have consistently been in top positions since the second half of 2024. The token consumption of large models has seen rapid growth, with Byte's daily token consumption increasing from 0.12 trillion in May 2024 to 50 trillion in December 2025. Looking ahead, it is expected that in 2026, model capabilities will focus on full modal, long-context, and Agentic capabilities, driving application development and increasing training and reasoning demands. In addition, with the upcoming IPOs of companies like Zhipu and Minimax, they are expected to serve as valuation benchmarks for internet models, pushing for value reevaluation. Infrastructure: As constraints on overseas computing resources ease and domestic computing capabilities improve, CAPEX will continue to expand. According to company announcements and Bloomberg consensus, Alibaba and Tencent are expected to have capital expenditures of 130 billion and 82.9 billion respectively in 2025, accounting for 12.7% and 11.0% of revenue, much lower than Microsoft, Amazon, Google, and Meta at 32.7%, 17.5%, 25.3%, and 35.2% respectively, mainly due to constraints on high-end overseas computing resources and domestic chip capacity. Looking ahead to 2026, it is expected that internet companies will further expand their CAPEX investments, driven by the easing of constraints on overseas computing resources, improvement of domestic computing capabilities, and overseas expansion of domestic cloud vendors. Based on company performance meetings and announcements, from FY25Q3 to 26Q2, Alibaba's cumulative investment in AI infrastructure and AI product development exceeded 120 billion, with expectations to increase investment beyond the planned 380 billion CAPEX in the previous 3 years. Tencent's CAPEX in 2026 is also expected to significantly increase. AI applications: Business empowerment, native applications, and edge-side innovation are advancing in parallel, revealing the rapid growth of AI applications. The improvement of model capabilities lays the foundation for the development of AI applications. 1) AI enables traditional businesses. The dividends of improved recommendation accuracy and production efficiency enabled by AI in advertising, gaming, e-commerce, etc., are expected to be rapidly released in 2026. 2) Accelerated iteration of AI native applications. With the improvement of model capabilities, it is expected that major internet companies in 2026 will increase the deployment of AI native applications, incorporating richer content, goods, and services ecosystems to compete for higher entry value. It is recommended to pay attention to the version updates and user growth trends of AI native products such as Bytepack, DeepSeek, Yuanbao, Qianwen, and Quark, as well as the potential of native AI apps in vertical scenarios such as Ant Fork and Lingguang. AI Agent, as a high-level intelligent entity for deeper understanding of high-value scenarios, is also expected to achieve breakthroughs in capabilities and application scenarios in 2026. 3) A variety of AI edge products such as Bytepack Phones, Quark Glasses are flourishing and are expected to reshape human-machine interaction logic and business models. Industry perspective: Focus on performance visibility and valuation cost-effectiveness. For companies with lower AI relevance, performance visibility and valuation cost-effectiveness will be the core factors influencing stock prices. From a performance perspective, the stability of the competitive landscape and macro sensitivity are core influencing factors. The bank believes that 1) vertical industry leaders with relatively stable competitive landscapes are likely to maintain performance resilience. 2) Emotion-driven consumption fueled by supply innovation is expected to maintain high prosperity. In addition, as major instant retail platforms began to focus on optimizing efficiency from Q4 of 2025, the bank believes that if the industry's competitive intensity continues to soften, core players could see stock price reversal opportunities in 2026. Risk factors: Unexpected tightening of liquidity leading to a downward shift in market valuations; Internet companies fail to reduce costs and increase efficiency, leading to underwhelming performance; New business and market expansions fall short of expectations, or investment losses exceed expectations; Risk of core shareholders reducing their holdings, etc. Investment strategies; Policy implementation falls short of expectations.