Why These 5 Chinese Stocks Should Scare You

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Includes: BIDU, DANG, SINA, TUDO, YOKU
by: Investment Underground

By Joe Escalada

Chinese internet stocks should scare you because their prices might reflect the fusion of not one, but two market manias: the euphoria that drove the tech bubble and the social media bubble combined with the dogmatic faith placed in emerging markets.

A decade ago, speculators in the tech bubble said that traditional valuation metrics didn’t apply because internet stocks were truly different. Today, speculators in the People’s Republic of China say warning signs of a collapsing construction bubble should be ignored because the PRC is different.

These phenomena do not last forever. Since the (first) tech bubble burst, academics have studied how executives exploited this euphoria by renaming companies with “.com” suffixes, and their share prices benefited. Many companies have changed their names to highlight connections to China. I suspect plucky professors will find how simple name changes that connected a company to China were rewarded by today’s crazed market participants.

As investors, we must try to avoid speculative bubbles and try to find prices that reflect a company’s intrinsic value. Reasonable valuations based on earnings, free cash flows, or book value are a requirement for avoiding bubbles. Without these guides, a value cannot be estimated. Let’s consider the relative valuation metrics of E-Commerce China Dangdang Inc. (NYSE:DANG), Youku.com Inc (NYSE:YOKU), Sina Corp. (NASDAQ:SINA), and Tudou Holdings Limited (NASDAQ:TUDO):

Ticker

P/E (ttm)

P/E (forward)

P/S (ttm)

P/B

Dividend Yield

DANG

633.64

6.76

N/A

2.75

0.00%

YOKU

N/A

2,124

27.91

3.83

0.00%

SINA

N/A

50.81

13.26

4.22

0.00%

TUDO

N/A

N/A

9.1

8.76

0.00%

BIDU

63.43

32

30.4

28.7

0.00%

Clearly, these stocks are very unattractive from a relative value perspective. What if we consider total return over a three- and five-year holding period that incorporates analyst growth estimates? Since these are “hot stocks,” let’s assume that we could sell them at a trailing twelve months price-to-earnings ratio of 16 (this would be a defensible, conservative estimate for growth stocks). For earnings growth, let’s give them the benefit of the doubt and allow them the higher of historical five-year growth or analyst future 5-year estimates. Finally, since some of these ran a loss last year, we can allow them forward price-to-earnings multiples in lieu of trailing multiples.

3 Years Growth

5 Years Growth

Ticker

g (past)

g (future)

Terminal P/E

Annualized Return

Terminal P/E

Annualized Return

DANG

N/A

48.26%

194.43

-57%

1.40

38%

YOKU

N/A

48.33%

965.38

-75%

438.77

-61%

SINA

6.48%

25.03%

32.50

-21%

20.79

-9%

TUDO

N/A

N/A

N/A

N/A

N/A

N/A

BIDU

87.30%

47.26%

19.86

-7%

2.60

42%

These three- and five-year scenarios are very, very hard to stomach. YOKU and SINA do not provide positive returns, even under the best earnings growth scenarios. Worse, there is no basis of positive earnings (historical or forecasted) to even pose a scenario for TUDO. DANG and BIDU manage to provide a positive return in these fanciful models, though they would not look attractive given conservative growth estimates. It is clear from a modeling perspective that these securities resemble venture capital more than they resemble value investments.

We can confirm this by looking at their past results as publicly traded companies. BIDU, described as the Google (NASDAQ:GOOG) of China, has had positive earnings and positive free cash flows since 2004. DANG is an internet marketplace much like Amazon.com, and has enjoyed positive earnings in 2010, and 2009, but has had negative free cash flows during these years. SINA is a provider of online media content in China. It has had positive free cash flows since 2004, and has had mixed earnings that are positive on average. TUDO's and YOKU’s past results are less heartening, with losses and negative free cash flows for each of their three listed years. The historical financials corroborate a venture capital profile for TUDO and YOKU. BIDU and DANG would qualify as being very richly valued growth stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.