The house rules are simple in this weekly column.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, Shanda Games (Nasdaq: GAME).

Game over?
When Shanda Interactive (Nasdaq: SNDA) decided to spin off its online gaming appendage last year, it raised a few eyebrows. Why spin off its bread-and-butter unit? Did the move make it easier to expand its gaming business internationally? Would Shanda Interactive remain relevant when its biggest asset was a majority stake in Shanda Games, with little else going on elsewhere?

Well, we now see that Shanda Games may have actually been an albatross in disguise. Its third-quarter report earlier this week was another dud. Revenue tanked 14% to $163.6 million. Earnings of $0.15 a share fell short of the $0.18 that analysts were banking on. They should know better, since Shanda Games is 0-for-4 in beating Wall Street's profit targets as a stand-alone public company.

The irony here is that Shanda Interactive itself did manage to post a modest year-over-year gain in revenue. Its online nongaming arm faltered, but business more than doubled at Ku9, where it cranks out board games, books, and other endeavors. However, none of that growth factors into Shanda Games, which embarrassingly suffered double-digit declines in both its multiplayer stronghold and the Web-based casual games that were supposed to offer diversification.

Shanda Games is upbeat about its future. Its pipeline is brimming with new games and it recently formed a strategic partnership with Square Enix to operate Final Fantasy XIV in China. Unfortunately, every quarterly report includes a glowing account of its upcoming releases. How has that been working out for shareholders so far? The stock may have gone public at $12.50 a little over a year ago, but it's been meandering in the single digits since mid-January.

If investors are going to take on the risk inherent with buying into China, they may as well go with leaders instead of fading laggards.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.
 

  • NetEase.com (Nasdaq: NTES): If you're going to play the online gaming market that's been magnetic to China's youth over the years, go with the star. During the same three months that found Shanda Games backpedaling, NetEase grew its revenue and earnings by 61% and 49%, respectively. NetEase also reintroduced Activision Blizzard's (Nasdaq: ATVI) World of Warcraft franchise in China with spectacular results. The icing on the balance sheet cake for NetEase is that it's loaded with $1.3 billion in cash.

  • Baidu (Nasdaq: BIDU): China's leading search engine isn't cheap, but the growth justifies the markup. Shanda Games' parent may have suffered a 10% revenue slide at its nongaming Internet business, but Baidu is rocking. Revenue soared 86% in its latest quarter, and earnings more than doubled. Trading at 44 times next year's projected profitability may not be for the squeamish, but it is growing considerably faster than that.

  • Changyou (Nasdaq: CYOU): This may not be China's leading online gaming specialist, but it's shaping up to be the value play among the smaller players that are still growing. Analysts expect earnings to climb from $2.81 a share last year to $3.26 a share this year. The pros see $3.68 a share come 2011, pricing the shares at a mere eight times next year's bottom-line target. Perfect World (Nasdaq: PWRD) can also be had for just eight times next year's earnings, but I'm wary of that company's earnings struggles in recent quarters. After NetEase, Changyou.com is easily the most attractive player in this niche.

I'm sorry, Shanda Games. Let me know when you're ready to come out and play again. Please take our Motley Poll and then scroll down to leave a comment explaining your reasoning.

Baidu, NetEase.com, and Shanda Interactive Entertainment are Motley Fool Rule Breakers selections. Activision Blizzard is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.