The pandemic and its effects on the economy over the past three years have had a volatile effect on Sea Limited's (SE -1.26%) three business segments: Garena is its internet gaming business; Shopee is its e-commerce operation; and SeaMoney is its fintech application. It results in accelerated growth as well as sharp pullbacks. Moreover, general market sentiment toward all early-stage, high-growth, and unprofitable companies (the exact characteristics of Sea Limited) turned decidedly negative last year. As a result, the stock had a horrendous 2022.

2023 has been a different story for the stock, and it started the year with a bang, rising 60.52% year to date. Why has sentiment on the stock shifted so rapidly? And should investors take it as a sign to get on the bandwagon and invest as well? Let's discuss this.

Revenue growth decelerated rapidly in 2022

Many growth investors fell in full-bloom love with this company back in 2018 when Sea Limited began putting up quarter after quarter of triple-digit, year-over-year revenue growth -- a trend that only ended in early 2022 when revenue growth apparently fell off a cliff. It was around then that market sentiment turned sour and the stock price dropped 77% during the year. 

SE Revenue (Quarterly YoY Growth) Chart

SE Revenue (Quarterly YoY Growth) data by YCharts.

Like many other unprofitable growth companies that spent money with abandon when times were good, Sea pivoted to becoming a more disciplined spender in hopes of achieving sustainable, profitable growth. Management had announced as far back as the fourth quarter of 2021 that it wanted to achieve profitability and positive free cash flow (FCF) across many of its markets and business segments by 2025.

When any company rapidly goes from a growth-at-all-costs mindset to a profitable growth mindset, it generally results in a painful hangover. For example, according to The Information, by mid-November of 2022, the company had eliminated 7,000 workers (about 10% of its workforce) through layoffs. Even worse, at the end of 2022, Bloomberg reported that Sea had suspended wage increases for many employees and was paying lower yearly bonuses -- counterproductive choices for company morale and potential future growth.

Things are looking up in 2023

Before it reported its Q4 2022 earnings on March 7, many were less than optimistic that Sea's cost-cutting initiatives would produce profitability anytime soon. For instance, consensus analyst earnings estimates called for a generally accepted accounting principle (GAAP) EPS loss of $0.75.

Investors were pleasantly surprised, however, when the company delivered its first positive GAAP EPS of $0.72, walloping consensus EPS estimates.

SE EPS Diluted (Quarterly) Chart

SE EPS Diluted (Quarterly) data by YCharts.

The company also shifted from negative total adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in Q4 2021 to positive in Q4 2022. Some people prefer looking at EBITDA because the metric shows a company's core profitability by eliminating abnormal gains or losses.

An image shows Sea Limited's adjusted EBITDA margin.

Image source: Sea Limited.

The company also produced its first positive free-cash-flow quarter in almost a year.

SE Free Cash Flow (Quarterly) Chart

SE Free Cash Flow (Quarterly) data by YCharts.

Investors are optimistic that Sea can produce sustainable, profitable growth and FCF once the global macro economy improves. In reaction to excellent Q4 2022 earnings, investors bid the stock price up almost 22%.

Why some investors are increasingly cautious

Some people believe that Sea's e-commerce website Shopee gained market share and rose to the top of the Southeast Asia market primarily through heavy marketing, free shipping subsidies, and other incentives. If that is true, then there are two substantial potential problems. First, heavy marketing spending to grow market share is not a long-term competitive advantage, and eventually, competitors will eat away at profitability margins.

Second, once a company that relies on heavy marketing spending to grow market share cuts that spending, it might begin rapidly losing market share, and revenue growth could slide -- a massive risk that Sea now faces.

The chart below shows that the company significantly cut sales and marketing spending in 2022 to help achieve profitability. Additionally, revenue growth fell. Can Sea's revenue growth woes be at least partially blamed on its cost-cutting initiatives?

SE Sales and Marketing Expense (Quarterly) Chart

SE Sales and Marketing Expense (Quarterly) data by YCharts.

Today, its shareholders expect a rebound in revenue growth once the economy normalizes. But without a boost from heavy marketing spending, chances are high that any revenue rebound from Sea will be far more muted than the market expects. Southeast Asia is a fiercely competitive market, and there is no guarantee that the company can maintain its market share without heavy marketing.

Should you buy the stock?

Despite the significant boost in stock price to start the year, the company has many issues. First, its digital entertainment division (Garena) continues to lose users.

An image shows Sea's Digital Entertainment user growth trends.

Image source: Sea Limited.

Second, its e-commerce (Shopee) and fintech (SeaMoney) businesses are early-stage businesses without significant competitive advantages in a highly competitive market. As a result, Sea could still lose its top-dog status as Southeast Asia's e-commerce and digital payments market matures.

Although its price-to-sales ratio of 3.76 looks enticing, the company has too many unknowns.

Considering this stock's colossal stock run-up to begin the year and the risks the company faces, investors might be better off sitting on the sidelines.