What happened
It was tough going for Sea Limited (SE 0.05%) shareholders last month. The stock fell another 32.8% in January, according to data provided by S&P Global Market Intelligence. It was a continuation of the sharp sell-off across growth stocks that started at the end of November. Over the course of the last few months, Sea has now lost some 60% of its value.
Image source: Getty Images.
So what
By now, you might have heard that the U.S. Federal Reserve said it will be raising its benchmark short-term interest rate, most likely starting in March. Higher rates decrease the present value of stocks, and high-growth, richly valued companies like Sea are among the most sensitive to interest rate changes. Though Sea isn't a U.S. company (it operates primarily in Southeast Asia), its stock is listed in the states. Thus, there's been a sharp sell-off of late as investors flee higher-risk, premium-valued names in favor of higher quality stocks.
Now what
Additionally, some investors have grown suspicious of Sea's aggressive expansion plans. There's no denying the Singapore-based, tech giant's strategy has worked wonders in the mostly emerging market countries of Southeast Asia, but the company is now moving into other regions (like India, Latin America, and Europe) where its popular Free Fire video game is popular. Sea hopes to be able to use the same template of success that worked at home, cross-selling its newer e-commerce services (by way of the Shoppee app) to gamers.
So far, it's working -- at least as far as sales growth is concerned. Total revenue increased 122% year over year in the third quarter of 2021. Total gross profit increased at an even faster 148% year-over-year rate, an early indication that Sea is benefiting from positive economies of scale (when a company's profit margins increase as it gets bigger).
However, the rub for many would-be Sea shareholders is a lack of profitability, as measured by adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA): negative $166 million in Q3 versus positive $120 million the same quarter a year ago. It is worth mentioning that Sea is free-cash-flow positive over the last 12-month stretch (positive $342 million), but maximizing profit is not the name of the game for this fast-moving tech empire.
With growth stocks like Sea currently out of favor, investors now need to weigh whether or not they're willing to ride out the higher-than-average volatility the stock will exhibit in a rising interest rate environment. Clearly, Sea is growing at a rapid pace, but slim-to-no profits can cause some wild swings in valuation. Shares currently trade for 223 times trailing-12-month free cash flow even after the crash.
Nevertheless, if you believe that Sea can pull off its aggressive expansion plans and you're eyeing the potential years down the road, current stock price is of far less concern. Rather than betting the farm, though, I'd advise making smaller purchases, perhaps on a monthly or quarterly basis, and building toward a larger position in Sea over time.
