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One of the hottest growth narratives in the market over the past 12-24 months has been the Chinese internet growth narrative.
It has become increasingly clear during that time frame that China is urbanizing at an unprecedented rate. This is big news because China has so many people. China's working population numbers 770 million, more than five times as big as America's working population.
Therefore, as these 770 million Chinese consumers start to adopt the consumer behavior of America's 140 million consumers, growth will be huge and far-reaching. This all translates into more shopping, more internet usage, more social media usage, more digital advertising … essentially, more everything.
Investors have been concerned about the longevity of this growth narrative, but a recent wave of strong earnings reports from big Chinese internet players implies that we are far from the end. Indeed, given just how many people are in China, we still might be in the early innings.
By and large, I think Chinese internet stocks will continue to trend up over the next several months, quarters and years. Here are my three favorite picks.
Chinese Internet Stocks: Weibo Corp (WB)
My first pick on this list is Chinese social media company Weibo Corp (ADR) (NASDAQ: WB ).
Many investors consider Weibo the Chinese Twitter Inc (NYSE: TWTR ). But WB would probably be offended by that comparison. After all, WB has more users than TWTR, is growing much more quickly than TWTR and is much, much more profitable.
Why? Probably because there isn't a Facebook Inc (NASDAQ: FB ) in China to steal all the users and engagement. There are other large social media platforms hosted by Tencent Holdings Ltd (OTCMKTS: TCEHY ), but the use case of those platforms doesn't cannibalize the use case of WB. Plus, Weibo does a great job of distinguishing itself from the Chinese social media pack through investments in short video and social relations.
All in all, as the Chinese internet growth narrative continues to explode and more and more consumers adopt social media, Weibo should concurrently grow.
Just look at the numbers. Revenue growth was 67% at the beginning of last year. It ended the year at 77%. Revenue growth for the full year was 75%, up from just 37% last year. Its expected to be 70% next quarter.
Considering Weibo only has 400 million monthly active users against WeChat's near 1 billion user base and that social media competition is relatively muted, I think there is a clear roadway for Weibo to get to a billion users. That means these 50%-plus revenue growth rates aren't going anywhere any time soon.
Then there is the whole margin growth narrative. Adjusted EBITDA margins are exploding higher, but they are still only at 40% (versus nearly 60% operating margins for Facebook). In other words, there is a ton of room for even further margin expansion.
A steady 50%-plus revenue growth rate plus huge margin drivers means that the consensus long term earnings growth rate of 65% is actually quite reasonable. But WB stock is trading at just 50-times forward earnings for that 65% long term earnings growth, implying a price-to-earnings/growth (PEG) ratio of less than 1. Throw a market-average PEG ratio of 1.2 on WB stock, and all the sudden we are talking about a $200-plus stock.
Given the company's robust growth prospects and discounted valuation, I think above $200 is where this stock heads over the next 12 months.
Chinese Internet Stocks: Baidu Inc (BIDU)
While my first pick on this list was the Chinese Twitter, my second pick is the Chinese Google Inc (NASDAQ: GOOG , NASDAQ: GOOGL ).
No matter where you are, China or the United States or anywhere else, search is a staple of the internet. In order to find essentially anything on the internet, you use a search engine. Consequently, one of the safest bets on the China internet growth narrative is a bet on China's dominant search engine.
China's dominant search engine is Baidu Inc (ADR) (NASDAQ: BIDU ). Indeed, Baidu's dominance in the China digital search market is bigger than Google's dominance in the U.S. digital search market. Baidu controls upwards of 76% of the search engine market in China. Google's search engine market share in the U.S. is under 65% .
BIDU stock has struggled recently because advertisers pulled away from the platform after a tragic online advertising controversy in early 2016. But BIDU has moved past that headwind, and growth is back. Revenues increased 29% last quarter, 20% last year, and are projected to grow more than 20% this year.
That growth rate makes sense, and looks awfully familiar. Just look at Google. Revenues over there have been growing at a 20%-plus rate for what seems like forever. I think the same thing plays out with BIDU. This is a 20%-plus revenue growth narrative over the next several years.
Operating margins are booming higher, and they are still only at 22%, versus 25% for Google. So there is still room for expansion in there. A 20%-plus revenue growth rate plus solid margin drivers should lead to at least 25% earnings growth. Slap a market-average 1.2 PEG on that, and you get to a fair forward multiple of 30, which on next year's $9.58 EPS estimate, gets you to a near $300 stock.
I think that is where BIDU stock will trend in the near term - and much higher than that in the long term.
Chinese Internet Stocks: JD.Com Inc (JD)
Source: Daniel Cukier via Flickr
One social media company. One search engine company. What else do you need for full exposure to China's internet growth narrative?
A digital retail company. When you say China e-commerce, most people think of Alibaba Group Holding Ltd (NYSE: BABA ). While I think BABA stock is a great long-term investment, I think rival JD.Com Inc(ADR) (NASDAQ: JD ) is an even better investment.
Most people liken Alibaba to Amazon.com, Inc. (NASDAQ: AMZN ), but it's actually more like eBay Inc (NASDAQ: EBAY ) with a cloud business while JD is more Amazon-esque. Unlike BABA and more like AMZN, JD actually owns its inventory. Plus, JD owns a massive logistics network, the likes of which Amazon is trying to replicate in the U.S. JD is also making a massive offline retail push, very similar to what Amazon is doing with Whole Foods Market. Better yet, JD is really pushing for global expansion, with its eyes set on a big European expansion starting this year. Much like AMZN, JD wants to be a widely recognized company for consumers around the globe.
Based on the similarities, I think JD is an Amazon in the making, minus Amazon's cloud business. That means JD stock will inevitably grow into its valuation as the China internet growth narrative continues to mature.
Overall, I think JD stock is a must-own over the next 5 years.
As of this writing, Luke Lango was long GOOG, BIDU, BABA, JD, and AMZN. Compare Brokers
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