China's Best-Kept Secret

It's completely understandable if you overlooked Sohu.com's (Nasdaq: SOHU  ) earnings report yesterday.

For starters, the Chinese new media specialist posted its second-quarter results at the New York City equivalent of 2:30 in the morning. Many of its stateside shareholders were probably sleeping -- or at least hoping that they were.

Alluding to Apple's (Nasdaq: AAPL  ) "most sought after iPad" as a new app development platform for Sohu wasn't enough to awaken Mr. Market from its dreamy summertime slumber.

Sohu also isn't typically the first company that investors think of when it comes to Web-based companies in the world's most populous nation. If the name of the game is online advertising, SINA (Nasdaq: SINA  ) and search leader Baidu (Nasdaq: BIDU  ) command larger market caps and breezier trading activity. If online gaming is the hot topic, pioneers NetEase.com (Nasdaq: NTES  ) and Shanda Games (Nasdaq: GAME  ) lead the way -- not Sohu's majority stake in Changyou.com (Nasdaq: CYOU  ) .

Effectively straddling both realms is a sound diversification strategy for Sohu, but it often means that Sohu flies beneath the radar in two different industries.

That's a pity, because Sohu's quarterly report deserved a larger audience. Revenue rose 15% to $146.1 million. Fully diluted earnings clocked in at $0.82 a share, ahead of last year's $0.79-a-share showing. Sohu landed ahead of analyst targets on both fronts, sending the shares 2% higher yesterday. It also issued near-term guidance ahead of where Wall Street is currently perched.

However, the real head-turning aspect of Sohu's report is that its Internet brand advertising business grew more quickly than its Changyou-driven gaming efforts. The 22% spurt in advertising revenue, which trumped the 17% gain at Changyou, contradicts the notion that multiplayer Internet games were the real driver at Sohu over the past couple of years.

This matters more than you think. The market has placed a premium on companies that specialize in online advertising. Baidu and SINA trade at 38 and 23 times next year's bottom-line targets, respectively. Sohu, on the other hand, fetches a multiple of just 11 times next year's projected profitability -- smack dab in the middle of Shanda Games' year-ahead price-to-earnings ratio of 9 and NetEase's ratio of 13. If Sohu's online advertising business continues to flourish, its valuation should follow suit.

That won't happen right away. Sohu's $53.5 million in brand advertising is just 36% of its revenue mix. Online gaming commands a thicker 53% slice. However, it's certainly a significant part of Sohu's business, and a one-way ticket to higher multiples, chunkier share prices, and a large, attentive audience the next time an earnings report kicks out at 2:30 in the morning.

Given the escalating political tension between China and the United States, is it still a good idea to invest in Chinese stocks? Share your thoughts in the comment box below.

Baidu, NetEase.com, and Sohu.com are Motley Fool Rule Breakers recommendations. Apple and SINA are Motley Fool Stock Advisor selections. Try any of our Foolish newsletter services, free for 30 days.

Longtime Fool contributor Rick Munarriz has been a fan of China's high-margin online stocks for a long time. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1247356, ~/Articles/ArticleHandler.aspx, 9/19/2014 4:02:51 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement