Dang, This Stock is Hot!

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E-Commerce China Dangdang Inc. (NYSE: DANG) might be a stock with a funny name to U.S. investors, but the company has been extremely hot recently. The provider of a business-to-consumer e-commerce platform in China has surged around 100% since opening at the beginning of May at around $3.80.

In general, Chinese internet stocks have struggled over the last year or so. The sector was hot during 2010 when Dangdang came public and quickly hit $35. But since then, Chinese stocks in general have come under fraud concerns, and the growth rate of the country has slowed, leading investors to dump internet stocks regardless of value and growth potential. Even leading internet stock Baidu has been crushed in the last year.

Improving results fueling stock

In reality, it didn’t take much for Dangdang to see improvements that led to strong stock gains. The stock only had a valuation of $300 million prior to these significant gains. With a revenue base expected to surpass $1 billion and grow around 24%, the stock could have more room to run.

The main reason for the surge in price is the strong improvement in margins. The previous concern was that the company wouldn’t ever turn a profit. For Q1 2013 the net loss dropped to only 5.5% of revenue, down from 7.6% last quarter and 9.2% in the year ago period. That substantial improvement provides some hope that Dangdang will be able to utilize its $255 million cash balance to push towards a profitable future.

Another exciting aspect is the massive 193% growth in gross merchants value (GMV) of the marketplace. While only accounting for roughly $9 million of revenue, the company continues to forecast growth nearing 200% for the current quarter.

Low China internet values

Dangdang is seen as the Chinese equivalent of an Amazon (NASDAQ: AMZN) since both began as online booksellers. While Amazon transitioned away from focusing on selling books years ago, Dangdang is just now making that transition. Even with a faster growth rate and the potential in China, Amazon trades at a higher valuation than Dangdang, at nearly two times its revenue base with razor thin margins. Amazon has a market cap of over $128 billion, and revenue is expected to reach nearly $75 billion this year. The massive online retailer wasn't even profitable last year.

Though Dangdang is transitioning to becoming more of a shopping mall, providing flash sales for brands and other marketplace options, it trades at a discount to Amazon due to fraud fears for Chinese stocks. Clearly it is impossible to expect Dangdang to repeat the long-term success of Amazon, but it is executing a transition that should help it accelerate growth and margins at a faster clip than Amazon can grow.

Another Chinese internet stock, Vipshop Holdings (NYSE: VIPS) trades at substantial discounts to growth rates. Vipshop calls itself the leading online retailer for Chinese brands, and expects revenue to grow 120% this year, yet the stock trades at only roughly 1 times revenue. Analysts see revenue leaping another 46% to $2.3 billion in 2014. The market cap sits at only $1.9 billion.

Even with Vipshop surging some 500% since the IPO last year, the valuation remains compelling at those levels. While investors are unlikely to give the stock a 10 times revenue multiple that a domestic stock would obtain with that growth, it doesn’t appear unreasonable for it to eventually trade at between 2 and 3 times revenue.

Bottom line

The recent gains of Dangdang would shock just about every investor as the market largely ignores Chinese stocks. Even though valuation metrics still favor buying the stock at these levels, it is difficult to buy with the continuous fears of fraud.

The incredible growth and low valuation multiple of Vipshop compared to Amazon clearly highlights the ongoing disconnect. At the very least, investors should begin following Chinese internet stocks as their valuations and long-term growth prospects make the stocks compelling as the fraud fears disappear quarter by quarter.

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Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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