Personal Finance

Should You Buy Tencent Holdings After the Correction?

A chalkboard drawing of a scale with reward on one side and risk on the other.

Shares of Chinese tech giant Tencent Holdings (NASDAQOTH: TCEHY) are down more than 13% as of this writing over the last month. In spite of the company's impressive momentum , several factors have converged to drive the stock down the last couple of months. Uncertainty abounds, but this looks like a great time to back up the truck.

What happened?

In its just-reported quarter ending its 2017 fiscal year, Tencent reported revenue growth of 56% to $36.4 billion and profit increased 75% to $11.1 billion. That's a fantastic year, right?

Not so fast. Investors honed in on slowing profit margin increases during the last quarter of the year as the company invests heavily for the future. That doesn't sound bad, but after a year in which Tencent's stock more than doubled, a lot is riding on its upward revenue and profit trajectory continuing. With cash being taken out of the bottom line to pay for further expansion, a breather was in order.

Added to the mix was a global market sell-off that has plagued many stocks since February as well as fears of a trade war between the U.S. and China. Regulators in the Chinese government have also shown renewed zeal in their censorship of the internet as of late, a practice that many fear could put a damper on Tencent's growth.

A chalkboard drawing of a scale with reward on one side and risk on the other.

Image source: Getty Images.

Why Tencent will be OK

Tencent is the global leader in video gaming , a massive empire that generated more than $3.7 billion in the last reported quarter. Despite its size, the company's largest segment still grew by 32% year over year as smartphone-based games continued to increase in popularity.

There could be plenty more of that ahead as Tencent continues to monetize its users on its social media platform WeChat. One of the ways they are doing that is introducing new app-based games to WeChat's users. Third-party game developers were also recently allowed onto the WeChat platform, paving the way for more sales from in-game advertising if the social media users like the new options.

Speaking of WeChat, Tencent is China's social media leader with 963 million users at 2017 year-end. Though its flagship service trails Facebook 's more than 2 billion users, WeChat is only just beginning to generate money through various advertising means. Advertising -- be it on social media or on the company's streaming TV service -- grew 49% in the last quarter.

Then there was expansion in the "other businesses" segment, which include things like cloud computing and online payments. Year-over-year growth of 121% was the figure given, good for $2.2 billion in the fourth quarter. Much of Tencent's investing activities that drug down profit margins happened here. With triple-digit annual returns, its hard to fault management for allocating some attention to the burgeoning areas of cloud and payment processing, even if it means a profit slowdown in the short term.

All of this impressive growth can be currently had for a forward price-to-earnings ratio of 27.3. That may look like a rich valuation, and if profit margins do get squeezed from short-term investing, the figure could get worse. However, revenue growth is strong and management sees lots of runway ahead in advertising, video streaming, and cloud services. A slimmer bottom line now is acceptable in exchange for a bigger company a little later.

Though storm clouds of uncertainty have thrown shade at Tencent as of late, momentum is on the tech giant's side. With the stock down double digits, the sell-off looks overdone. To me, this looks like a great time to pick up some more shares of one of China's biggest and fastest-growing companies.

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Nicholas Rossolillo and his clients own shares of Tencent Holdings and Facebook. The Motley Fool owns shares of and recommends Facebook and Tencent Holdings. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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