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Throw This Stock Away

The house rules are simple in this weekly column.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, Shanda Games (Nasdaq: GAME  ) .

Game over?
When Shanda Interactive (Nasdaq: SNDA  ) decided to spin off its online gaming appendage last year, it raised a few eyebrows. Why spin off its bread-and-butter unit? Did the move make it easier to expand its gaming business internationally? Would Shanda Interactive remain relevant when its biggest asset was a majority stake in Shanda Games, with little else going on elsewhere?

Well, we now see that Shanda Games may have actually been an albatross in disguise. Its third-quarter report earlier this week was another dud. Revenue tanked 14% to $163.6 million. Earnings of $0.15 a share fell short of the $0.18 that analysts were banking on. They should know better, since Shanda Games is 0-for-4 in beating Wall Street's profit targets as a stand-alone public company.

The irony here is that Shanda Interactive itself did manage to post a modest year-over-year gain in revenue. Its online nongaming arm faltered, but business more than doubled at Ku9, where it cranks out board games, books, and other endeavors. However, none of that growth factors into Shanda Games, which embarrassingly suffered double-digit declines in both its multiplayer stronghold and the Web-based casual games that were supposed to offer diversification.

Shanda Games is upbeat about its future. Its pipeline is brimming with new games and it recently formed a strategic partnership with Square Enix to operate Final Fantasy XIV in China. Unfortunately, every quarterly report includes a glowing account of its upcoming releases. How has that been working out for shareholders so far? The stock may have gone public at $12.50 a little over a year ago, but it's been meandering in the single digits since mid-January.

If investors are going to take on the risk inherent with buying into China, they may as well go with leaders instead of fading laggards.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

  • (Nasdaq: NTES  ) : If you're going to play the online gaming market that's been magnetic to China's youth over the years, go with the star. During the same three months that found Shanda Games backpedaling, NetEase grew its revenue and earnings by 61% and 49%, respectively. NetEase also reintroduced Activision Blizzard's (Nasdaq: ATVI  ) World of Warcraft franchise in China with spectacular results. The icing on the balance sheet cake for NetEase is that it's loaded with $1.3 billion in cash.

  • Baidu (Nasdaq: BIDU  ) : China's leading search engine isn't cheap, but the growth justifies the markup. Shanda Games' parent may have suffered a 10% revenue slide at its nongaming Internet business, but Baidu is rocking. Revenue soared 86% in its latest quarter, and earnings more than doubled. Trading at 44 times next year's projected profitability may not be for the squeamish, but it is growing considerably faster than that.

  • Changyou (Nasdaq: CYOU  ) : This may not be China's leading online gaming specialist, but it's shaping up to be the value play among the smaller players that are still growing. Analysts expect earnings to climb from $2.81 a share last year to $3.26 a share this year. The pros see $3.68 a share come 2011, pricing the shares at a mere eight times next year's bottom-line target. Perfect World (Nasdaq: PWRD  ) can also be had for just eight times next year's earnings, but I'm wary of that company's earnings struggles in recent quarters. After NetEase, is easily the most attractive player in this niche.

I'm sorry, Shanda Games. Let me know when you're ready to come out and play again. Please take our Motley Poll and then scroll down to leave a comment explaining your reasoning.

Baidu,, and Shanda Interactive Entertainment are Motley Fool Rule Breakers selections. Activision Blizzard is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks in this story. Rick 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 (5) | Recommend This Article (9)

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.

  • Report this Comment On December 01, 2010, at 5:32 PM, Varchild2008 wrote:

    (Devil's Advocate: ...since I have lots of money at stake in (GAME) )

    Q3 Revenue of 163 million was over 3 million more than Analyst expectations.

    So they may have missed on the bottom line again, but this time they BEAT on the top line.

    And how did they beat on Revenue?

    2 words.... DRAGON NEST

    And guess what? In Taiwan, Dragon Nest is King. It has knocked off World of Warcraft for CCU leader.

    Dragon Nest is planned for a North American release in 2011 by NEXON licensing it from Eyedentity Games (which is now entirely acquired by Shanda Games).

    Shanda Games via their Conference Call is considering the opening success in all regions where it is available as similar to WOOL / MIR II franchises.

    So Shanda Games is moving from their outdated MIR I & MIR II games to a much younger portfolio.

    Meanwhile, Legend of Immortals appears to be winning awards:

    CGDA Best Game Design Award Candidate

    2010 China Game Developers Award (Concept Art)

    Legend of Immortal is still in testing phase having gone into its 2nd Alpha testing back in late October of this year.

  • Report this Comment On December 01, 2010, at 10:19 PM, targetphil2 wrote:

    10 cents worth

  • Report this Comment On December 04, 2010, at 1:04 PM, whyaduck1128 wrote:

    I find a certain irony in a game named "Final Fantasy XIV". How many will there be before it's finally final?

  • Report this Comment On December 05, 2010, at 10:24 AM, Varchild2008 wrote:

    True Dat.

    But, the series isn't a real series. The games are not actually sequals. Each game in the franchise is a stand-a-lone storyline and world.

    It's Final Fantasy, but only for the particular world the game takes place in (i.e. the world is always coming to an end unless the heroes save the day).

  • Report this Comment On December 16, 2010, at 11:25 AM, dlomax77 wrote:

    The title was inspired either by the impending retirement of lead designer Hironobu Sakaguchi, or the bankruptcy Square would have filed for if the game hadn't been so successful, depending on which story you choose to believe.

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