Finding stocks with the potential to double in a year or less is rare, but that's exactly what Wall Street analysts project for Sea Limited (SE 5.21%). With an average one-year price target of $109 against a stock price of less than $50, there's clearly a lot of projected upside.

What does Wall Street know that investors are missing? Or is Sea Limited's stock just that undervalued? Let's find out.

One booming and one struggling segment

The first thing to know about Sea Limited is that it isn't a U.S.-focused company. Sea in the name is actually a reference to "Southeast Asia," which is also evidenced by its headquarters being in Singapore. It's a multi-faceted business and has a few segments you wouldn't think go together well.

Sea's original segment is Garena. Garena is a video game company whose most popular title is Free Fire, which has been the most downloaded game globally for a couple of years now. It attracts the third-most monthly active users for mobile games on Alphabet's Google Play store.

Unfortunately, Garena has been struggling lately. Quarterly active users were down 15% year over year in the second quarter, and paying users were down 39%. Overall, revenue for the Garena division slipped 12% year over year to $900 million. Free Fire, Garena's most popular title, has been around since 2017, so its popularity is leveling off, which is creating some drag on growth metrics. Additionally, Free Fire was banned in India earlier in 2022, eliminating a huge market.

These results worry investors because Garena, and Free Fire, have long been the revenue engine supporting the company's expansion into other revenue streams.

Sea Limited's other main division, the Shopee e-commerce store, is working hard to establish itself. Gross merchandise volume was up 27% year over year to $19 billion in Q2, driving revenue growth of 76% to $1.8 billion. Within its e-commerce business is SeaMoney, a young but growing mobile wallet offering.

E-commerce is still booming, so Sea Limited's business performance is relatively neutral. However, Free Fire's revenue has been funding Shopee's growth. As that cash cow shrinks, it puts further pressure on Sea Limited's bottom line.

Losses are mounting for Sea Limited

While combined revenue rose 29% year over year, cost of revenue rose 37%, meaning its gross margin is shrinking. Operating expenses also exploded higher in two particular areas.

Expense Growth (YOY)
General and administrative 96%
Research and development 115%

Data source: Sea Limited. YOY = year over year.

With administrative costs rising, investors may question where that money is going. Research and development expenses are a little easier to imagine; it could be working on new games, building out its digital wallet platform, or improving its e-commerce store. More than likely, that money is pouring into its e-commerce business as it is valiantly trying to build out its e-commerce offering by spending heavily on advertising in regions it's trying to expand into, like India, Latin America, and Southeast Asia itself. But with expenses doubling, questions about sustainability are arising.

With a net loss of $931 million, Sea Limited has a significant gap between its current state and profitability point. Management also did nothing to reassure investors with its guidance for the rest of 2022.

Management suspended guidance for 2022, citing a "strategic shift" to focus on the "efficiency and optimization" of its e-commerce business. However, after seeing expenses rise tremendously, the guidance suspension raises some serious red flags for me. Additionally, a memo floated by management a few months ago stressed that the company needs to become free-cash-flow positive because the financial markets are drying up, and thus Sea's access to additional capital will be limited.

That's also why Sea's price-to-sales valuation has been significantly reduced.

Chart showing Sea Limited's PS ratio falling in 2022.

SE PS Ratio data by YCharts

At 2.3 times sales, Sea Limited's stock may seem cheap. However, if the company genuinely focuses on its e-commerce business, it will trade like an e-commerce stock. Amazon (AMZN 0.83%) trades for 2.1 times sales, so Sea Limited is essentially in the correct price range.

I'm going to have to disagree with Wall Street's analysts here. I think Sea Limited's stock price at the moment is right about where it deserves to be. The company isn't executing well, has rising expenses, and is shifting its business model. I'm not saying Sea Limited's stock should be sold, but there is just too much uncertainty in the stock to take a position right now.

Amazon is a much better buy, in my opinion. Investors shouldn't try to hit a home run with Sea Limited when they have a clear and proven winner attractively priced in front of them.