Xiaofan Zhang's  Instablog

Chinese Internet stocks are the most dynamic segment among U.S.-traded Chinese stocks: In Baidu, Ctrip, and Sina, investors have found the "Chinese Google, Expedia, and Yahoo." Online gaming companies such as Shanda and NetEase have demonstrated the brilliant Chinese way of making money from video games. This article compares the P/E ratios of 10 largest U.S.-traded Chinese Internet stocks with at least $1 billion market cap (see table below), and discusses implications for investors.

  Table: Top 10 Chinese Internet Stocks' P/E Ratios and Growth Rates

Source: Yahoo! Finance and Google Finance

The table above ranks 10 largest U.S.-traded Chinese Internet stocks by P/E ratio, and lists their annual earnings growth for the next five years predicted by investment banks. The P/E ratio reflects two factors about a stock: potential growth and investment risk. Typically, a high P/E means high growth and low risks.

Key findings:

Baidu is the clear leader of the group. Ranking first in both P/E and growth, Baidu is a typical "high growth, high P/E" stock. What investors expect from Baidu is mainly lots of growth in the future. Adding to the high growth is Baidu's dominant 70%+ market share in China's Internet search market. Baidu has maintained this dominance since it went public in 2005. Baidu's high growth and stable market leadership have won it the highest P/E among the top 10 U.S.-traded Chinese Internet stocks.

Ctrip's second highest P/E seems to be inconsistent with its modest growth rate. However, its stock chart shows something other Chinese Internet stocks do not have: a four-year uptrend with very low risks prior to the global financial crisis. Ctrip's excellent track record of "safe driving" has won investors' confidence. As the Chinese economy recovers, investors are betting that Ctrip will once again become a safe China play.

Online gaming companies' growth potential has not been fully recognized by investors because of its risks. Although accounting for six of the 10 positions in the table, none of the online gaming stocks ranks among the top three. Notably, Perfect World and Changyou rank high in terms of growth potential, but their P/E ratios merely rank in the bottom half. These inconsistencies show that investors believe online gaming is riskier than Internet search (Baidu), online travel booking (Ctrip), and online advertising (Sina). Despite the high growth rates estimated by brokerage firms, investors are concerned with the regulatory and product risks involved in the online gaming business. The recent regulation on virtual currencies is a perfect example for such risks.

Disclosure: No positions