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When PEGs fly

4 July 2014 By Robyn Mak

China’s internet stocks are red hot but investors would rather pay more for their U.S. counterparts. Shares of Chinese companies including gaming and social media giant Tencent and search engine Baidu trade at lower multiples than those of Facebook, Google and other American dotcoms when expected earnings growth is taken into account. The discount is deserved.

Breakingviews compared price-to-earnings growth (PEG) ratios for Chinese and U.S. consumer internet stocks that were profitable in 2013. The PEG ratio is calculated by dividing a company’s forward price-to-earnings multiple by its expected earnings growth rate. The median PEG ratio for 13 U.S. dotcoms is 1.3, compared with a median ratio of just 0.9 for 12 Chinese companies, according to calculations based on StarMine data.

There are several possible explanations why Chinese web stocks listed in Hong Kong and New York trade at a discount. China’s internet industry is younger and has more room to grow – just 46 percent of the population was online at the end of last year, compared to 84 percent in the United States. But investors in Chinese companies face greater regulatory risks. For example, a government anti-pornography campaign knocked shares of web portal Sina in April.

The offshore ownership structures used by Chinese companies to list overseas also face legal uncertainties. Accounting concerns are another factor: the recent 32 percent plunge in shares of NQ Mobile, a Chinese mobile security firm which has delayed publishing its 2013 annual report, illustrates investors’ lack of faith in Chinese companies’ financial statements.

Doubts about growth outside China may also weigh on the shares. China’s web groups have been moving slower than their U.S. counterparts when it comes to expanding overseas. It’s hard to see Tencent’s social network catching up with Facebook, which has almost 84 percent of its 1.3 billion monthly users outside North America. International revenue accounted for 55 percent of Google’s total in 2013. At Baidu, the figure was a paltry 0.2 percent.

Any comparison between companies operating in very different markets is always going to be imperfect. Analysts’ earnings forecasts can also prove to be wrong. For now, however, it seems investors are applying a discount to China’s dazzling internet growth. The valuation gap is justified.


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