Since I worote this ten days ago the markets have had a wild ride but most of my recommendations below just got a little more affordable so I would enjoy the discount and buy the dips.
I've hope you have enjoyed the market ride during the last few months as much as I have. Pretty much everything is up as the stock market has shrugged off all kinds of normally disturbing news: Revolutions in Egypt and Tunisia, soaring food prices, looming political deadlock in Washington over spending cuts, and more.
Despite all the turmoil, so far nothing has been able to keep this market down for long. The only problem - and it's a big one - is that it's getting harder to find stocks that are cheap enough so that you don't feel you are chasing a train that left the station a while ago. Valuations look a little stretched so, like everyone else it seems, I've been waiting for some kind of pullback that would enable me to add to positions that have been performing well. So far, that hasn't happened. Don't get me wrong. I'm not longing for another market crash, only a modest correction that would restore a sense of balance and provide new opportunities to deploy cash.
While I'm waiting, I've been looking at areas that haven't been doing particularly well. That led me to emerging markets which for the most part have been selling off. In some cases the drop has been fairly dramatic; for example the Indian NSE 50 Index is down more than 10% so far in 2011 and I'm not sure that the selling is over yet. Looking elsewhere, the FTSA China 25 Index is off about 15% from its highs of late last year but given the inflation scares in the emerging markets and the interest rate hikes in China it could have been much worse. Brazil, another fast-growing BRIC country, has also pulled back although not as much as either China or India.
All this started me thinking about which stocks and which sectors are relatively inflation-proof while offering exposure to emerging market growth, particularly in China. I kept coming back to a basket of Chinese Internet stocks which, with a few exceptions, have not significantly pulled back with the rest of the Chinese market.
There are a lot of things to like about the Internet in China where they had a total of 384 million web surfers at the end of 2009. That is greater than the entire population of the United States and that's with a penetration of only 23% so there is lots of room to grow. Overall usage is increasing at close to 30% a year with the Internet population growing at what likely is a conservative rate of 20% per year.
The Internet market in China is young; close to 70% of all web surfers are under the age of 30. That's why gaming sites like Shanda Games Ltd. (NDQ: GAME), which was spun off last year from Shanda Interactive Entertainment (NDQ: SNDA) looks interesting even though it has not performed well to date and is not my principal recommendation in this column.
There are number of ways to get exposure to Chinese Internet stocks and a site that I like called tickerspy.com has created an index which you might find helpful in researching these opportunities. It can be found here: http://tiny.cc/si8dx
As I scanned down that list, two stocks kept jumping out at me. The first was Baidu Inc. (NDQ: BIDU), which can be found at www.baidu.com. The website is in Chinese but Google will translate it for you. The second was Youku.com Inc. (NDQ: YOKU) which is at www.youku.com. These companies are the Google and YouTube of China respectively. Let me tell you a little more about them.
Baidu has been in the news a lot in the last year as they were seen to benefit from Google's decision to essentially withdraw from mainland China. Given their recent stellar results, they do seem to be profiting nicely. Recent fourth-quarter earnings were stellar, with revenue rising 94% and earnings soaring 171%. Baidu now has over 70% of the Chinese search market. If you like Google here in North America you have to love Baidu in China even though its forward p/e ratio is twice that of Google. Baidu's quarterly sales growth is close to four times that of Google and they have no real competition.
After the stock split last year I bought a position when it was trading in the $60s and sold when it reached $112. I have regretted that sell decision ever since and have been hoping for a pullback so I could reenter. Well, I'm finished waiting! I plan to take a position now and continue to add to it over time because I feel this is a long-term hold and the stock may well continue to move up a lot further over the next couple of years.
Youku.com is a different story. It fell by almost 50% after its IPO late last year but as I write it is rallying on heavy volume prior to its earnings call which is scheduled for Feb. 28. As I'm sure most of you know, Google purchased YouTube some time ago and it appears that deal is beginning to pay off for them. It has taken a while for video advertising to grow on the web, lagging behind the heavy traffic that video users have presented to the advertising community globally which is a phenomenon I can personally attest to as I own a large video site myself: www.streetfire.net. However, we are now seeing the advertising community begin to embrace online video sites which will be as good for Youku.com as it is for YouTube.
Imitation is the sincerest form of flattery and it is not a stretch to believe that both these companies may one day equal or surpass the success of the sites that they have copied. They have the Chinese government in their corner, offering a barrier to entry to sites originating from other countries. They also have a growing youth market and a strong economy. That's a pretty great combination of factors which should lead to continued exponential growth.
Both companies trade on Nasdaq as American Depository Receipts (ADRs).
Action now: Buy Baidu with a target of US$180. The stock closed on Friday at US$128.80. Buy Youko.com at US$34.50 with a target of US$50.