NetEase (NTES, Financial) will join the Nasdaq 100 index on March 16, replacing SanDisk (SNDK, Financial) which has been in the index since 2003. The move both confirms the importance of consumer-focused software tech companies and the rising significance of Chinese firms in shaping the future of technology.
The timing of the decision is interesting. NetEase is down 24% year to date and up 37% over the past year, with extreme volatility observed in the past six months. Ranging between $112 and $186, NetEase stock has gone up and down sharply alongside an uneasy Chinese stock market.
Despite the price volatility, the company’s financials have been solid and consistent. Revenues rose 128% year over year in the fourth quarter of last year and were up 18% quarter over quarter. The firm’s profit margin and operating margin have remained above 25%, although a decline in profit margins over the last four quarters has caused some concern from investors and contributed to the price volatility.
Still, at a P/E ratio below 18, NetEase offers revenue growth and exposure to a growing market where mobile and internet usage are continuing to rapidly expand. Last quarter, the company saw online games revenue more than double, and the gross profit margin on that segment is over 67%. Meanwhile, advertising services saw a 68% increase in revenue, and that gross profit margin is over 68%. With fast growth in high margin operations, the firm’s profit margins are far from threatened.
This sustainable profitability and high revenue growth have encouraged bulls to note the stock’s potential is overshadowed by a “sell anything China related” mentality that has hurt high quality firms as much as others. NetEase is just one of many China companies to face increasing selling pressure; Alibaba (BABA, Financial) has struggled to bounce from its 52-week low, while Baidu (BIDU, Financial), Sohu.com (SOHU, Financial), and Sina (SINA, Financial) have also met with growing investor suspicion. Any signal of bad news inevitibly hurts these stocks. Since NetEase's online gaming profits fell from 76% to 67% last quarter, the stock fell significantly on its earnings report, and some Wall Street analysts have expressed concern about the decline in subsequent reports.
However, that has not stopped many hedge funds and investment firms from buying the stock. BlackRock bought 10% more NetEase stock at the end of 2015, raising its total stake to over $8.1 million. Hedge funds Ardevora Asset Management and CIBC Asset Management also increased their NetEase holdings in recent months.
The declining value of the stock may offer another buying opportunity for these large firms, who see value in the firm’s growing EPS, skyrocketing revenue and large potential market among Chinese gamers. With the major China selloff in recent months, they may see a once-in-a-lifetime opportunity to buy good Chinese stocks for cheap prices, including NetEase. With Nasdaq confirming the solid fundamentals of the company, reasons to buy have just gone up.
Disclaimer: I have no positions in any of the stocks mentioned in this article and no intention to initiate a position within the next week.
