Few stocks have ever experienced the gut-wrenching journey of Sea Limited (SE 0.05%). In a span of about four years, it rose from obscurity to become a market darling, only to then be completely dismissed. If you purchased shares four years ago, at one point your investment was up over 1,000%. But if you bought in at its peak, you'd be down 90% as of this writing.
Sea stock hit its all-time high in late 2021, which coincides with the all-time high for the S&P 500. But Sea isn't down merely because the stock market turned sour, especially on growth stocks. A major blow to its video game segment in early 2022 became a driving factor in the stock's decline.
This is why investors need to pay attention now: Sea announced that problem just went away.
What happened to Sea in 2022?
Sea's business has three pillars. There are the e-commerce operations from its Shopee platform, a fintech segment in SeaMoney, and a digital entertainment arm, Garena. Within that last business, Free Fire is its most popular video game title (more on this later).
Back in 2021, Garena was the second largest segment with full-year revenue of $4.3 billion. That figure made up 43% of the company's top line, and it was up 114% from the previous year. Though Shopee recorded even more impressive growth of 136% with revenue of $5.1 billion, it was Garena's $2.5 billion of operating income that was funding the steep losses in the other two segments.
But in Feb. 2022, India banned Free Fire over national security concerns, and Garena eventually saw its revenue decline 9% for the year. Its share of Sea's top line shrank to just 31%. So far this year, the results have been even worse. Through the first half of 2023, digital entertainment revenue is down 47%, and it accounted for just 17% of total revenue.
In a positive development for Sea, TechCrunch reported on Aug. 31 that Garena is relaunching Free Fire in India. While I don't want to imply the video game's previous ban was the only important issue for Sea shareholders, but it undeniably hurt a key part of the business. And as the digital entertainment segment has limped along, Sea's financial results have disappointed, bringing down the stock as well.
The crazy thing for investors to know
Up to this point, it might seem like I'm describing a dying company, but Sea's revenue has actually continued to soar to all-time highs despite the headwinds in digital entertainment.
Data by YCharts. TTM = trailing 12 months.
Moreover, Sea's management recognized its growth headwinds and made major operational pivots in recent quarters, prioritizing profitability. Because of these changes, the company is now profitable in each of its three segments as of the most recent quarter. Therefore, profits are also at an all-time high for Sea right now.
That discipline has put the company on a strong foundation going forward. And now, growth could be on the cusp of revving back up now that Free Fire is going back to India. This latest news makes Sea stock a compelling buy.
Good investments need good business fundamentals -- that much is true. But many timely opportunities result from overly negative investor sentiment toward a stock. And I believe sentiment toward Sea is overly negative right now.
For evidence, consider the valuation of Sea stock. At a price-to-sales (P/S) ratio of just 1.7, the stock trades at a lower valuation than even many low-growth blue chip companies. And the valuation is at an all-time low, suggesting investor sentiment has never been worse.
Data by YCharts.
Simply put, I don't believe Sea stock has any valuation risk right now: Shares are cheap. If growth picks back up for the company and management leverages the operating efficiency put in place over the past year, then this company can easily create market-beating shareholder value from here, even if its valuation stays low.
That said, if Sea's digital entertainment division heats back up, it's possible investors will take notice and the stock's valuation will start climbing again. I wouldn't invest for this reason alone, but such a scenario would only add to the potential gains for Sea stock and make it a timely investment opportunity.
