This year, just as in 2017, appeared to be a golden one for Chinese publicly-traded companies. Popular names like Alibaba Group Holding Ltd (NYSE:BABA) and Tencent Holding/ADR (OTCMKTS:TCEHY) catapulted to a fantastic start. Unfortunately for Sohu.com Ltd – ADR (NASDAQ:SOHU) and stakeholders of Sohu stock, the multi-varied internet services provider just never got going.
The best that it did this year was to move up over 5% in late January. However, the markets snuffed out early optimism, with Sohu stock tumbling off a very poor fourth quarter 2017 earnings report.
Realizing that this was not the same Sohu.com that took home 25% returns last year despite cratering in the final quarter, investors decided to salvage what they could.
No one can blame them. In Q4, Sohu stock could only muster a loss of $2.01, which was far below consensus estimates calling for a loss of $1.44.
This result followed an ugly miss in Q3, where Sohu.com’s earnings per share slipped to $-2.38. Analysts that quarter expected the damage to be pared at 98 cents below parity.
To add insult to injury, the Chinese internet company absorbed another huge blow in Q1 of this fiscal year. Against an expected loss of $1.56, Sohu.com produced a ghastly loss of $2.50. After the result, SOHU dropped 10%. Worse yet, at the time, shares were down 38% year-to-date.
If Sohu.com was supposed to be a high-flying Chinese stock like its compatriots, they clearly lost the memo.
Is SOHU a Contender?
But now, the tables have turned dramatically. Several Chinese companies openly face questions due to severe geopolitical headwinds. For instance, I recently mentioned China Mobile Ltd. (ADR) (NYSE:CHL)
and China Unicom (Hong Kong) Limited (ADR) (NYSE:CHU) as two companies I’d avoid for now. And although it’s only been a few days, they’ve looked like incredibly risky investments.
On the other hand, Sohu stock has demonstrated an uncharacteristic robustness over the trailing two months. Its last significant miss in the markets occurred on the day management released Q1 earnings results.
Since then, the embattled company became a different species.
From the April 25 closing price, SOHU jumped nearly 52%. Few companies right now can touch that performance magnitude, especially within that kind of time frame.
That said, potential investors want to reassure themselves that they’re not merely buying into a dumb, contrarian gamble.
While it’s tempting to believe that it can’t get any worse than this, sometimes it can.
The major impediment I see moving forward with Sohu.com is its poor financials.
Yes, we saw a year-over-year revenue increase of nearly 22% to $455 million in Q1. But the issue is that it widened its net-income losses from $68 million to $93 million.
Nothing that I’m seeing indicates that this trend will reverse itself anytime soon. Since 2014, gross margins have declined consecutively, which sets up the company poorly further down the income statement.
Additionally, its operating margins are all over the map. Ultimately, this underperformance has resulted in five years of negative earnings. Not only that, the money drain is only widening.
About the only positive metric that stands out is its strong cash position relative to its debt levels. But with such horrid sales and earnings, this is merely a technical consolation.
Don’t Forget the Context
What’s most important to consider about Sohu stock isn’t that shares move higher, especially against its Chinese compatriots. Rather, it’s the reason for the move, and more to the point, whether it’s sustainable.
I argue that it isn’t. Since October 2017, short interest in Sohu stock has risen quite dramatically. Several weak-hands in this bearish trade were likely scared out of their positions, forcing them to cover.
Such panicked trades can easily create the massive burst we’ve witnessed in the past 60 days.
But this buying pressure can’t last indefinitely. Trader or investment sentiment doesn’t change the fundamentals, which will probably remain poor for a while. Moreover, only a little more than 1% of insiders own shares, while institutional ownership comes in at nearly 63%.
I point these things out because it appears insiders don’t believe that much in their own company. Next, heavy institutional ownership is a mixed bag. While they provide an influx of capital, they can also spark an outflow as well.
Institutions first and foremost care about their overall performance. As a result, their interest isn’t always aligned with the interests of the target stock’s shareholders.
Admittedly, Sohu stock’s recent performance caught many people by surprise. However, I wouldn’t jump on board the bandwagon. The low-hanging fruit is likely gone from this trade. But more critically, this firm could quickly fall back towards its original direction.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
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