prologue

Despite operating in a challenging environment, with several large players including Tencent (OTCPK:TCEHY), Alibaba (BABA) and Ping An Insurance (OTCPK:PNGAY) recording significant drops in EPS figures, NetEase of (Nasdaq: NTES) The fundamentals are stable. I believe NetEase is worth it because the stock price has been lowered because of political concerns, not because of weak earnings or future prospects.

NetEase is a Chinese company that provides online services focused on content, communication and commerce. The company develops and operates several online PC and mobile games, email and advertising services. NetEase has signed license agreements with major companies such as Mojang and Blizzard to bring some of their titles to the Chinese market.

foundation

NetEase’s revenue is growing at a rapid pace, declining for just a few quarters. The growth rate has averaged 30% annually dating back to 2010.

Growth eventually dipped into the low double digits as the company grew, which is still respectable given the size of the company.

This growth is largely a result of new games being released while existing games continue to grow. Slower revenue growth was expected as the game eventually matures and needs more revenue to move the needle.

Analysts expect revenue growth to continue next year.

Profit margins are at record highs, with no negative earnings in a year. However, after the explosive growth in revenue in 2015, margins have fallen. This is due to new games and licensing deals being made.

Since then, it has stabilized at around 17%.

Rapid growth in sales coupled with a declining but profitable net profit margin has resulted in significant net profit growth over the years.

Net profit growth averaged approximately 21% annually from 2010 to 2022. This growth is very impressive, especially given that it was achieved without diluting shareholders. EPS is also up about 20% year-on-year as the number of shares outstanding has barely increased.

capital allocation

As you can see in the image below, NetEase achieved about 100 million yen. Approximately 25% annual return on equity from 2010 to 2017. The returns are quite impressive considering that nearly all of the earnings were reinvested. Only a small portion of earnings have been paid out in dividends since 2013, along with occasional small share buybacks to offset the dilution.

Return on equity now appears to be stable at around 17%. Given that the company spends up to 25% of its earnings on dividends and will continue to reinvest his 17% in stocks going forward, shares and earnings should grow by up to 12.75% annually in the future.

The key point is that most of the earnings are reinvested. I think this is wise given his high double-digit reinvestment rate that management can achieve.

It’s reassuring to me that it seems to have stabilized and even increased in recent months. A strong reinvestment capacity underscores the company’s strengths and its moat.

evaluation

As seen in the image below, the CAGR from 2010 to 2022 is 19.74%. We can also see that growth has slowed in recent years. This was to be expected given the lower return on equity.

The annual EPS growth rate from 2010 to 2017 was 25.05%. In line with ROE for that period. Given ROE of about 17% from 2017 to 2022 and a dividend payout ratio of about 25% in the absence of meaningful share buybacks, a reasonable estimate of future annual EPS growth is about 12.75% will be

The projected growth rate is in line with analyst forecasts over the next two years, which analysts also forecast in the low double digits.

The company has been rewarded with a higher-than-usual earnings multiple as it has achieved above-average growth over the past decade. The average annual growth rate is 19.74% and the average multiple is 18.75. The return to average multiple shows a return of about 48%. The company should be trading at a higher multiple than its current multiple of 12.9x, but we don’t think the average multiple will provide a safety margin any longer, as we don’t expect it to grow more than 15% annually.

A return to the standard 15x profit margin seems more reasonable as it still represents upside potential of up to 20%.

stock chart

Disclaimer: Technical analysis by itself is not a sufficient reason to buy a stock, but when combined with company fundamentals it can significantly narrow your price target range when buying.

NetEase’s stock price is currently below the 50 moving average line, which has been a strong support area several times in the past. This is typical of consistently growing companies that NetEase classifies. A return to the 50 moving average shows a 40% return. This puts the stock closer to the average multiple and slightly above the standard multiple of 15.

However, if the current market weakness and the political situation in China catalyzes stocks to continue falling, we can expect strong support at the 200 moving average. I think the odds of such a low valuation happening are extremely low, but I think anything is possible in this market.

final thoughts

There is no doubt that NetEase is a strong business. The company has seen significant growth in fundamentals for years in a row and is not expected to stop anytime soon. Although the reinvestment rate has declined in recent years, it shows promising prospects for future growth. With a 17% return on equity and a ~25% dividend payout ratio, the ~12.7% annual growth estimate is very reasonable.

Given the 12.7% annual growth rate, the current valuation is very attractive. The company is trading well below its average earnings multiple. I think we can kind of justify the slowdown in revenue growth, but we have to at least give it a standard multiple of 15 going forward.

Part of the low valuation is due to the political fears surrounding Chinese stocks, but it’s clear that NetEase has less volatility than other Chinese stocks. The company is expected to see a slight decline in his EPS this year after a year of +30% growth.

Barring political turmoil, the company is expected to grow by double digits, but its earnings multiples are valued below average. The stock chart is in line with earnings and it might make sense to consider NetEase.

Therefore, I give the company a ‘buy’ rating.