What happened

It may be a new year, but for YY Inc. (NASDAQ:YY) the result is the same. In January, shares of the Chinese video-based social network jumped 18%, according to data provided by S&P Global Market Intelligence, building upon the mind-boggling 187% gain the stock produced in 2017.

YY Chart

YY data by YCharts

So what

When stocks post 100%-plus annual gains, it's often based on increases in valuation multiples more than top- and bottom-line growth. YY has been one of the rare exceptions to this rule. In the nine months ended Sept. 30, the company posted revenue of $1.2 billion, an increase of 158% over the prior year and a net income increase of 86%.

Young man wearing headphones and typing on a laptop.

Image source: Getty Images.

As a result, even after posing greater than 200% gains in the last 13 months, shares of the company trade at a price-to-forward-earnings multiple of 18 times, which is in line with the greater S&P 500. As an aggregate, the S&P 500 is not growing anywhere near the rate of YY, which points to a mispriced stock or analysts possibly being too bullish on the company's forward earnings.

Now what

All Chinese stocks, YY included, will benefit from demographic tailwinds. Two trends will boost YY: increases in disposable income and internet penetration rates. Recently, China's government reported 6.9% GDP growth in 2017, which will boost China's middle class and disposable income. Second, there's still room for China's internet penetration rate to grow. Although the country added 41 million new internet users in 2017 alone, the penetration rate is only at 56%.

While there are risks -- most notably, the company not being able to effectively monetize its huge and growing user base, and continued fears of nationalization and regulation by its communist government -- these concerns appear to be priced into the valuation. If YY can continue to post these admirable growth rates, it's the most undervalued stock in the market today.


This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.