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 Interactive (Nasdaq: SNDA ) .
Fasten your seatbelts
Shanda investors may be doing victory laps after last night's better-than-expected quarterly report, but what are we celebrating, exactly?
Revenue climbed a mere 2% year over year to $232.3 million, devoid of strength in Shanda's two core businesses. Its Shanda Games (Nasdaq: GAME ) online gaming arm posted a 14% year-over-year decline in revenue. Shanda's online portal suffered a 9% top-line dip.
Shanda's revenue only inched higher because its hodgepodge of endeavors lumped together as "other" revenue actually more than doubled.
Hold your applause until you see what's really behind Door No. 3. Shanda's "other" businesses include difficult-to-monetize sites featuring literature, video-sharing, and board games. Investors buying into Shanda for the promise of China's booming online gaming industry or sizzling portal potential may be shocked to find those flagship endeavors slipping even as China's web migration grows.
This wouldn't be so bad if there were some "other" catalyst, but there isn't. Gross profit margin for Shanda's "other" revenue clocked in at a pathetic 22%. Compare that to the gross margins in the company's fading online and gaming businesses, at 75% and 61%, respectively.
The end result of this sad stew: Adjusted earnings were nearly cut in half to $0.46 a share, despite the flattish top-line showing. Sure, analysts were only targeting a profit of $0.39 a share on $217.7 million in revenue, but this only means that investors should adjust their level of pessimism.
Once-great Shanda was one of the earliest Motley Fool Rule Breakers recommendations, but David Gardner chose to take the small gain amassed over six years and bump it off the scorecard back in January.
It's just no longer the growth stock that some investors think they're still buying. It's also not much of a value stock, fetching more than 20 times trailing earnings.
There are companies growing in gaming and cyberspace in China. Buy those instead.
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.
Sohu.com (Nasdaq: SOHU )
China's best match for Shanda is Sohu.com, a dot-com pioneer with a strong presence in both website portals and online gaming through Changyou.com (Nasdaq: CYOU ) . It makes this week's cut because it moved ahead during the same three months in which Shanda retreated. Revenue surged 30% during the fourth quarter. Sohu's brand advertising, online gaming, and search businesses all posted year-over-year gains of 30% or better. There were no "other" sandbags here. Margins widened as earnings shot up 41% during the period. It's also even cheaper than Shanda, trading for 17 times this year's projected profitability vs. a forward multiple of 23 at Shanda.
Baidu (Nasdaq: BIDU )
Shares of China's leading search engine aren't cheap, but that's never stopped Baidu from becoming one of the best-performing Internet stocks over the past few years. Its latest quarter was so full of win that Charlie Sheen wants to hang out with it. Revenue soared 94%. Earnings skyrocketed 171%! If investors are looking for a growth-stock vehicle in China, this is the bullet train.
Activision Blizzard (Nasdaq: ATVI )
Investors gun-shy about actually investing in China can get the best of both worlds by buying into this leading gaming software company. Activision Blizzard's World of Warcraft has been a huge hit in China since it was reintroduced there in 2009 through licensing partner NetEase.com (Nasdaq: NTES ) . On the console front, Activision Blizzard took its lumps when it axed its fading Guitar Hero franchise, but the company still set initial sales records with Call of Duty: Black Ops back in November.
I'm sorry, Shanda. You're just no longer in demand-a.