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, E-Commerce China Dangdang (NYSE: DANG  ) .

Throwing the book at China
Dangdang was a hot IPO when it made its Wall Street debut three months ago. The fast-growing online retailer's offering was priced at $16 a share. It wasn't enough. It opened at $24.50, closing at a mind-boggling $29.91 on its first day of trading.

The stock is trading lower than its first-day close now, but that doesn't necessarily make it a bargain.

Dangdang finally reported its fourth-quarter results this morning. Revenue growth was strong, with sales climbing 59% to $107.7 million. Adjusted earnings, however, fell 25% to $2.6 million. Earnings per share on a GAAP basis came in at $0.03.

Analysts were expecting a profit of $0.02 a share on $106.6 million, so Dangdang did its part by landing ahead of the pros. The rub is that this isn't the kind of blowout performance that validates the stock's lofty valuation.

Dangdang relies largely on shipping low-priced books to make a living. It stocks a massive 620,000 book titles. Its average order is for a little more than $12. Dangdang is trying to expand into bigger-ticket wares, but media items still account for more than three-quarters of its business.

Margins, as you may imagine, are pretty meager. Net margins improved only marginally in the full 2010 year, and are still mired in the 1% to 2% range.

Investors that are used to ridiculously fat margins out of China's dot-com darlings are in for a rude awakening with its e-tailers. It's not just Dangdang. Apparel e-tailer Mecox Lane (Nasdaq: MCOX  ) posted results last week, and it too clocked in with net margins just shy of 2% for all 2010.

Historians may kindly point me to Amazon.com (Nasdaq: AMZN  ) circa the late 1990s. It was even posting losses -- as Dangdang did in 2007 and 2008 -- before cleaning up nicely. However, it's not fair to call Dangdang the Amazon.com of China. It's still too early. There are also plenty of competitors (including Amazon itself).

Dangdang closed out the quarter with 4.4 million active customers, 47% ahead of where it was during 2009's final period. Total orders rose by only 34%, but the 59% spike in revenue means that consumers are placing larger orders.

It is targeting revenue to grow by 50% to 52% in the current quarter, implying deceleration in its growth rate. I won't mark Dangdang down for that. Chinese companies have a refreshing way of underestimating their guidance, and we haven't seen enough of Dangdang on the quarterly earnings stage to know if it's low-balling reality.

This is simply a valuation call. Dangdang is a company to watch, but it's just not worth its $2 billion market cap until margins improve dramatically. Adjusted earnings may have nearly doubled to $6.2 million last year, but it has a long way to go before it grows into its chunky valuation.

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.

  • Amazon.com: I wasn't impressed with Amazon's holiday quarter. Net sales climbed 36%, but earnings inched just 8% higher. The margin-crunching excuse here, at least, is that Amazon is sacrificing near-term results to outfit millions of bibliophiles with cheap Kindle e-readers. This is a strategy that will pay off nicely when Barnes & Noble (NYSE: BKS  ) follows Borders to the elephant graveyard of print publishing. Dangdang hasn't even crossed that obsolescence test. I should also point out that Amazon still came through with $2.5 billion in free cash flow last year, more than even Dangdang's lofty market cap.
  • Baidu (Nasdaq: BIDU  ) : I can't recommend any of China's e-tailers. Mecox Lane is a busted IPO with decelerating growth. Dangdang may take a couple of years to justify its price tag. In this climate, I may as well go with the thicker margins generated by the country's undisputed search leader. Baidu is the paid search champ in China. Its latest quarter was spectacular. Revenue and earnings soared 94% and 171%, respectively. Baidu isn't cheap at 33 times next year's projected profitability, but this one is actually worth the premium.
  • Funtalk (Nasdaq: FTLK  ) : It may take a few years before China's economy grows to the point where small-ticket e-tailers like Dangdang can make serious money on orders larger than its current $12.37 average. The fulfillment costs are just not right to strike a winning balance between consumers and merchants. Let's stick to the real world until then. Funtalk operates 718 retail outlets in more than 110 Chinese cities. It is growing quickly and trades at ridiculously cheap P/E multiples of 7 based on this fiscal year (which ends this month) and 6 looking at the year ahead.

I'm sorry, Dangdang. You're just one dang too many.  

Baidu is a Motley Fool Rule Breakers recommendation. Amazon.com is a Motley Fool Stock Advisor selection. 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 (6) | Recommend This Article (6)

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  • Report this Comment On March 10, 2011, at 2:21 AM, benedekgb wrote:

    hi.

    1. Having lived in Eastern Europe, I can see the same development line in China as in many Eastern European countries. Especially with internet comanies. Based on parallels, DANG will be huge, and I would be surprised in it grew 70-100% per year, not 50. You see, the model is already out there. Dang can offer ebook readers for example. The market for growth is spectacular.

    At this point I would be worried about it not securing number 1 place in China. But it is doing this well. After this is established brand recognition the increasing middle class will create a huge demand.

    2. It has many market oportunities it has yet not entered.

    3. People order more...? What exactly is your problem with this? This is exactly what happened at amazon, and this is not a problem, but an opportunity in itself.

    4. Margins for amazon are 3%. I am sure Dang will get there. That in itself is a 300% possible margin increase. Off course this will happen as the market matures.

    5. Dang is actually making money (profitable). Just remind me, how long did it take for amazon to do the same?

    I am a betting man, and I wager you that within the next 2-4 years, this will really become the "amazon" of chna, possible also the ebay. I am expecting it price to double or triple in 2-3 years. Off course no one nows the future, so we shall have to wait and see. But just for the one, I wager 1 dang share, whatever its worth 2 years from today:)

  • Report this Comment On March 10, 2011, at 3:23 AM, benedekgb wrote:

    2 more points:

    1. Amazon was listed may 1997, become profitable at the very end of 2011.4 and a half years, and around 7 years from start.

    Dang is already profitable.

    2. When Amazon started, and when it became profitable the internet penetration was on a guestimate around half or even a third of the chinese market at the moment. And (the chinese) market is still growing fast.

    Dang has a much larger and growing market to grow on. How you figure its a flop is beyond me. Sure in the short term, the price may go down. I am not a momentum trader, so I do not know when to get back on board, but I am pretty confident growth will exceed projections.

    +1: As mentioned amazon was and is the market leader, but dang knows china. its only job is to build brand recognition and adopt all that is good and working at amazon. that it is actually profitable at this moment is icing on the cake.

  • Report this Comment On March 10, 2011, at 5:29 PM, addedupon wrote:

    AMZN made it thru the tough times because it has a giant, a true genius as its leader. AMZN made it because Besos willed it.

    same is true for AAPL MSFT GOOG WMT DELL BIDU and others. its the leadership not the model. companies grow or shrink to the size of their leadership. anyway, that's how i see it.

  • Report this Comment On March 11, 2011, at 3:03 AM, benedekgb wrote:

    i remember a time when beyos was loved, and a time was he was a pariah in the news.

    dont get me wrong i am not blind, and will say, dang may even loose another 50%. however, i maintain that in the longer term (1-3 years) it will be well over the 50 USD share price. I also maintain its sales growth will exceed 50%.

  • Report this Comment On March 11, 2011, at 4:18 AM, benedekgb wrote:

    tcw aqcuires 4% stake in dang. large investment bank yesterday increased target price to 36USD, outperform.

    you will be eating your words my friend.

  • Report this Comment On March 12, 2011, at 5:33 AM, benedekgb wrote:

    this guy will not even reply, he is so high in his ivory toer of know it all. he also reccomended throwing away youko. if you did that you would be about 50% gain in little less then 3 months. these are viewpoint articles, nothing more. my viewpoint, throw this guy away:) nothing personal.

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