Chinese Internet Stocks: In Search of Growth and Value (BIDU, CTRP, GIGM, JOBS, JRJC, LONG, NCTY, NTES, SINA, SNDA, SOHU)

Why choose between growth and value when you can have both?

Investors love high growth stocks with a reasonable valuation. The PEG Ratio, defined as the stock's P/E ratio divided by the growth rate of its earnings, is a good empirical tool for identifying undervalued growth stocks.

A popular rule of thumb is to consider a stock underpriced if its PEG falls much below 1, and overpriced if the PEG is much greater than 1.

PEG Results for China Internet Stocks

As you can see, NCTY sports the best PEG (0.15), followed by GIGM (0.54). At the other extreme, SINA has the worst PEG (3.38) followed by LONG and CTRP.

Calculating PEG requires some assumptions, the most controversial being the estimate of the earnings growth rate. For the sake of this analysis, the earnings growth rate was calculated as the two year average of the analyst consensus growth rate estimates for 2006 and 2007 (see methodology section below).

2006-2007 P/E Ratios and Earning Growth Rates

Methodology

When calculating PEG, we are faced with the following questions:

1. Which earnings to use?

For growth stocks, historical earnings are usually irrelevant. Investors generally buy these stocks for their future earnings. A good number to use is the current year (or next year) analyst consensus earnings estimate.

2. How to estimate earnings growth.

Ideally, you should use a long term growth estimate. However, most analysts provide estimates for only one or two years out. Longer term growth rates can be very difficult to estimate for growth stocks.

In this article we are using a 2 year compounded average growth rate derived from average analyst consensus earnings estimates for 2006 and 2007. Not quite a long term growth rate, but the best we can get.

Stock prices used in our calculations: Monday June 5, 2006 market closing prices.

Full Disclosure: The author owns NCTY shares and June Call Options.

Related: See all Seeking Alpha charts on Chinese stocks traded in the U.S.