The stock of NetEase (NAS:NTES, 30-year Financials) appears to be significantly overvalued, according to GuruFocus Value calculation. GuruFocus Value is GuruFocus' estimate of the fair value at which the stock should be traded. It is calculated based on the historical multiples that the stock has traded at, the past business growth and analyst estimates of future business performance. If the price of a stock is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher. At its current price of $106.6 per share and the market cap of $73.1 billion, NetEase stock is estimated to be significantly overvalued. GF Value for NetEase is shown in the chart below.
Because NetEase is significantly overvalued, the long-term return of its stock is likely to be much lower than its future business growth, which averaged 18.3% over the past three years and is estimated to grow 19.30% annually over the next three to five years.
Investing in companies with poor financial strength has a higher risk of permanent loss of capital. Thus, it is important to carefully review the financial strength of a company before deciding whether to buy its stock. Looking at the cash-to-debt ratio and interest coverage is a great starting point for understanding the financial strength of a company. NetEase has a cash-to-debt ratio of 4.79, which is in the middle range of the companies in Interactive Media industry. GuruFocus ranks the overall financial strength of NetEase at 8 out of 10, which indicates that the financial strength of NetEase is strong. This is the debt and cash of NetEase over the past years:
Investing in profitable companies carries less risk, especially in companies that have demonstrated consistent profitability over the long term. Typically, a company with high profit margins offers better performance potential than a company with low profit margins. NetEase has been profitable 10 years over the past 10 years. During the past 12 months, the company had revenues of $10.8 billion and earnings of $2.568 a share. Its operating margin of 19.61% better than 75% of the companies in Interactive Media industry. Overall, GuruFocus ranks NetEase's profitability as strong. This is the revenue and net income of NetEase over the past years:
Growth is probably one of the most important factors in the valuation of a company. GuruFocus' research has found that growth is closely correlated with the long-term performance of a company's stock. If a company's business is growing, the company usually creates value for its shareholders, especially if the growth is profitable. Likewise, if a company's revenue and earnings are declining, the value of the company will decrease. NetEase's 3-year average revenue growth rate is better than 67% of the companies in Interactive Media industry. NetEase's 3-year average EBITDA growth rate is 9.2%, which ranks in the middle range of the companies in Interactive Media industry.
Another method of determining the profitability of a company is to compare its return on invested capital to the weighted average cost of capital. Return on invested capital (ROIC) measures how well a company generates cash flow relative to the capital it has invested in its business. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. When the ROIC is higher than the WACC, it implies the company is creating value for shareholders. For the past 12 months, NetEase's return on invested capital is 18.96, and its cost of capital is 4.22. The historical ROIC vs WACC comparison of NetEase is shown below:
To conclude, the stock of NetEase (NAS:NTES, 30-year Financials) gives every indication of being significantly overvalued. The company's financial condition is strong and its profitability is strong. Its growth ranks in the middle range of the companies in Interactive Media industry. To learn more about NetEase stock, you can check out its 30-year Financials here.
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