Not all Chinese stocks are overvalued or out of favor. NetEase (NTES 1.09%) hit an all-time high on Tuesday, and that was before posting blowout financial results after the market close. NetEase was fetching just 22 times its new trailing adjusted earnings as of Tuesday's close.
The stock has been one of the market's top performers since going public at $15.50 in the summer of 2000. Adjusted for a 4-for-1 stock split back in 2006, the stock has been better than a 100-bagger -- a 102-bagger, to be exact -- over the past 20 years, and that's before tacking on the steady flow of dividends along the way.
Judging by this week's financial update, it seems as though NetEase isn't done impressing the market with its better-than-expected first quarter.
Image source: Getty Images.
Playing to win
NetEase delivered 18% top-line growth through the first three months of this year, and a double-digit gain is no small feat in China, which experienced the brunt of the COVID-19 crisis earlier this year. A 14% increase in its bread-and-butter online gaming business -- accounting for nearly 80% of the revenue mix -- paced the strong performance.
Its 2019 spinoff Youdao (DAO -0.56%) is growing even faster, with its revenue soaring 140% over the past year. Youdao is an intelligent-learning company that happens to be one of the leaders in e-learning in China, a niche that is naturally booming as physical schools temporarily closed in response to the pandemic. Youdao accounts for just 3% of the $2.4 billion in total revenue for the quarter at NetEase, but obviously, it's moving the needle with its explosive growth.
NetEase continues to own roughly two-thirds of Youdao after last year's IPO. The balance of NetEase's other segments, including its online music business, delivered 28% year-over-year growth for the period.
The news gets even better as we work our way down the income statement. Gross and net margin widened, resulting in adjusted earnings per share clocking in 30% higher than a year earlier. Analysts were only holding out for 18% in adjusted earnings growth on $2.2 billion in revenue, but that's not a surprise. NetEase has consistently come through with double-digit beats on the bottom line in recent quarters.
| Quarter | EPS | EPS Estimate | Surprise |
|---|---|---|---|
| Q4 2018 | $1.96 | $1.52 | 29% |
| Q1 2019 | $3.39 | $2.28 | 49% |
| Q2 2019 | $3.96 | $2.62 | 51% |
| Q3 2019 | $5.12 | $3.12 | 64% |
| Q4 2019 | $3.97 | $3.50 | 13% |
| Q1 2020 | $4.60 | $4.01 | 15% |
Data source: Yahoo! Finance.
You might have missed the better than 100-fold return on the stock through its first 20 years of trading, but it's not too late. NetEase continues to have a strong pulse on gaming trends in China, and shareholders share in the prosperity beyond just the market-thumping capital appreciation. NetEase sets its quarterly dividend rate at roughly 20% to 30% of its anticipated after-tax earnings, so those payouts should continue to improve.
No one will argue that investing in China stocks isn't risky. However, NetEase has been successfully trading since 2000, has a smart quarterly distribution policy in place, and is trading at a reasonable earnings multiple. You can't go back in time to grab this 100-bagger, but the future is still bright for NetEase.
