Is Sea Ltd. An Attractive Stock At This Price?

Scoring Sea's Quality and Valuation

Hi Friends

Paying members of Potential Multibaggers, my paid Seeking Alpha service, get very regular updates about the stocks I have picked and they own (or not, as that’s their own choice). And I do that very systematically. Of course, the earnings are analyzed in all detail, but I have also developed a few scoring systems to assess the quality of a business and how attractive a stock is to buy right now.

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If you have already read about earlier PMQS, the QPI score, and the BHS scale, you can skip the next few paragraphs and go to the scores immediately or you can read it again to refresh your memory.

PMQS means Potential Multibaggers Quality Score. It’s essential to understand that it’s not just QS, quality score, but PMQS. What I mean is that stocks are not just scored on their overall quality but also on their potential to multibag. I think nobody questions the quality of Apple (AAPL) and it would score very well on several parameters (like financial stability, for example) but poorly on others (multibagger potential and revenue growth, among others) and overall, its PMQS would be rather mediocre. I focus on multibaggers, though, and that’s when you have to score for multibaggers, not only for quality, which remains a very important part of the equation as well.

I introduced the PMQS in 2022 when I saw that I had been deceived by some sweet-talking CEOs who knew what I (and other growth-oriented investors) wanted to hear. But it was just that, talk. The PMQS looks at all the granular details to see if the numbers match the talk. To put it differently, the PMQS should help me avoid losers like Twilio, Peloton, Teladoc, DocuSign and Stem. It was the PMQS that showed me clearly I had to sell these stocks and I did. At small or big losses, for sure, but all have either crashed a ton more (Stem, Teladoc, Peloton) or have gone nowhere since (Twilio, DocuSign).

Okay, so with the PMQS, you know how good a stock's quality is and how much potential it has to multibag, but how attractive is it to buy right now? That depends on the valuation, of course, and that’s where the QPI comes in.

QPI stands for Quality-Price Index. The name already suggests it: with the QPI score, I balance quality and price. The reasoning is that higher quality often deserves a higher price and lower quality a lower price and if you bring those two together, quality and valuation, you get a better idea if a stock is attractive to buy now or not.

How I do this is simple: I score the valuation out of 10, divide the PMQS by 10 and then add them up. I rank the scores of all my picks and that’s how I can see which are most attractive to add to. On top of that, I follow up the price of the stocks. If there’s a 20% move up or down, I update the valuation to see if the stock has become more or less attractive with the price movement.

The BHS scale is then simply a visual representation of how I see a stock based on the QPI. BHS simply stands for buy, hold, sell. But I don’t want to simply tag these terms, I put them on a scale to not oversimplify things. Often, it’s something between two things.

Before we go scoring Sea Limited (SE), don’t forget to subscribe, so you don’t miss these free updates. Or did I ask that already? ;-)

Personal conviction 8/10

Lowered in November 2023

Based on everything I/you know about the company, this is mainly my or your own conviction. Your own conviction may be very different here and you can adapt this score to your own liking.

You can download the sheet here to give your own score alongside me.

Sea used to have 10/10 for me, but the changing macro conditions first brought that down to 9, and in November 2023, it dropped further to 8. In hindsight, it’s easy to judge that I was too optimistic but if the macro environment hadn’t changed so fast, Sea’s position would have probably been different. But ifs don’t count in investing. So, why still a high personal conviction score of 8/10 for a company many have written off in the last years?

I still like what I see. I can't repeat enough what I have said before: the company has made the most impressive switch from growth to value I have ever seen, going from a ('GAAP') net loss of almost a billion dollars to almost $500 million in GAAP profits in just two quarters (unless in a special situation, which was not the case here).

In the last few quarters, the company makes losses again but that is by choice and the losses are much lower and already declining.

Forrest Li showed an impressive ability to control his company very well. Jeff Bezos did something similar in 2001 to show investors that Amazon could be profitable if it wanted, but it took Bezos two years, not two quarters.

By the way, all the beautiful charts are made with Finchat. Did you know there’s a free version, so you can make similar charts yourself? And if you decide to pay, it costs 1% of a Bloomberg subscription and has 95% of the features. If you use this link, you even get a 15% discount if you take a paying option.

Profitability 7.5/10

Last change July 2024

I am pretty sure this score will change regularly, as Sea will invest and focus on profitability at the same time. As you saw in the above chart, Sea was not profitable in the last quarter if you look at GAAP net income as it invested heavily in Shopee.

If you look at Free Cash Flow, though, you see the impressive achievement continues.

Finchat

That's why I continue to balance GAAP loss in recent quarters versus the positive free cash flow with a score of 7.5/10. That's up half a point, as the FCF was up in Q1 2023 compared to Q4 2023 and GAAP net loss was also much better.

Sales efficiency 6/10

Changed in July 2024

The sales efficiency score first looks at the marketing efficiency by looking at what percentage of revenue goes to SG&A (selling, general and administrative) and how much revenue growth that brings in the trailing twelve months and what is expected next year. I divide the average of those two by the SG&A number as a % of revenue and that is marketing efficiency. I then multiply that by the gross margin to look at sales efficiency.

Of course, this formula is far from perfect, but it gives you some idea of how well the company is selling its product. There are plenty of nuances to add here, but the numbers are what they are.

These are the numbers for Sea:

E-commerce will always have lower margins than, for example, SaaS companies and that means the score is actually pretty good.

Innovation 4/5

Since Q3 2023

This is part subjective, part measurable. The measurable part is how many new products the company issues versus its competitors? But the magnitude of the innovations is much more important than the sheer number of innovations.

You can also look at the % of the revenue that goes to R&D. At the same time, I want some efficiency there too, so I look at R&D efficiency by dividing R&D expenses in the previous year by revenue growth in the trailing twelve months.

Sea spends 8.15% of its revenue on R&D, which is not high, but that also comes because in retail revenue is high and margins low.

With revenue growth of 22.8%, the R&D efficiency is very high at 2.68, but it was just 0.71 the previous time I updated this. Now, Sea is clearly high in the first quartile.

When you look at the pace of innovation at Sea, it is breathtaking when the company expanded. Don't forget that the company only started Shopee in 2015, and it's already the biggest all over Southeast Asia. It has a market share of a whopping 48% in the region and it said it continues to win market share. Number two, Lazada, the previous leader before Shopee disrupted it, stands at just 20%; the rest follows even much further, including TikTok, which was seen as the Shopee killer prematurely by many speculators.

SeaMoney was another initiative that was grown internally, very fast and it's now a substantial part of the business.

If you could say one thing, it's not that Sea hasn't innovated fast enough, to the contrary, it probably innovated faster than it should, looking back, with many new countries it started with Shopee. But that is looking back, with hindsight bias. Nobody could foresee interest rates would rise at the fastest pace in history.

I'm keeping my score at 4/5.

Must-have? 3/5

Unchanged since the start

I introduced this because of what Matthew Prince, the founder and CEO of Cloudflare (NET) said, as I reported in the Overview Of The Week #125:

I think that the world is about to get sorted into must-haves and nice to haves.

Is Sea a must-have? That's a hard one and the question will be 'it depends'. What I mean is that people will often buy online faster when they are more money-constrained, as they know that prices are often lower. So, Shopee might benefit in that way.

Of course, discretionary spending goes down during recessions.

This is what I wrote when I introduced the PMQS in 2022.

For Shopee, I think all in all, the influence would be limited because of these to counteracting forces. But Garena, Sea's very profitable gaming division, will probably see more influence of a recession if it would come.

So, I'm giving Sea a 3/5 here.

The results so far prove me right here, and I see no need to change anything about the score.

Revenue growth 4/5

Last change July 2024

This is very simple: how high was the revenue growth over the last twelve months? For Sea, that is 22.8%, so I'm raising my score to 4/5.

Revenue growth durability 7.5/10

Raised in July 2024

At least as important as revenue growth, is the durability of revenue growth. A

For Sea, with its several divisions and constant new initiatives, in developing markets, I think that the durability of revenue growth is high, but not as high anymore as before. There is more competition now. However, Shopee showed strength and that's why I slightly raise the score to 7.5, up from 7/10.

Management Quality Score 9.5/10

Unchanged since the start

Great management is often one of the most important keys to long-term success. I look at the track record here, so execution, and the vision.

For Sea, I see a fantastic track record and really fast shifting from the management team when circumstances demand that. I'm deeply impressed by how Forrest Li thinks and innovates. If you want to read how he writes to his employees, for example, you can do that here.

He has decentralized management functions and he trusts his CEOs. For example, Chris Feng is the CEO of Shopee since 2015, so from the start and he has hit the ball out of the park. Forrest Li monitors, lays out the strategic lines and adapts if necessary.

I rate him and his team 9.5/10. The only reason why I don't give him 10/10 is that, while he is a great writer, he's not really an inspiring speaker. On conference calls, he usually only gave the prepared remarks, but that has changed since Q3 2023.

Insiders' Ownership 5/5

Does management have skin in the game? This is out of 5 as it is not always a make-or-break but often it's a useful indication.

For Sea, Forrest Li owns a very big chunk.

As you can see, he owns 17.9% of the shares, and that's on a fully diluted share count.

At the current price of $65.34, this means Forrest Li's ownerstake is worth more than $7 billion. As you can see from the rest of the table, others in the management team also have big stakes, like Gang Ye, co-founder and COO, who also owns more than 35.6 million shares. That also puts him at firmly above $2 billion.

I don't think we need to make this any longer, a clear 5/5.

Multibaggers Potential Now 4/5

Since March 2024

The company has evolved so much since I picked it at a market cap of $21.5B. It now has a market cap of $37.5 billion. It still has multibagger potential, in my opinion, considering its very long runway and the early phase Sea is still in. But of course, there are no guarantees. This score is for the potential. That's important.

TAM/SAM: 5/5

Initiated March 2024

TAM stands for total addressable market and SAM for serviceable addressable market, the market you serve because of your specific product and geographical limitations.

I can be very short about this one. Both the TAM and the SAM are huge, especially because many of the countries Sea operates in are growing like weeds. Indonesia is expected to be the fourth-largest economy by 2050, after China, the US, and India.

Shopee alone would already have a huge TAM & SAM but Garena and SeaMoney only add to that size.

So, only a 5/5 can be correct here.

Financial Strength 7.5/10

Last change November 2023

In this environment, financial stability is much more important too. That's why I rate it out of 10.

Sea had a few quarters of amazing profitability, mainly because of the speed with which it reached profitability from steep losses. While this quarter was not profitable on a GAAP basis, free cash flow remained firmly positive.

With Finchat, there's a new option of stacking, where you can compile different (preferably related) stats on top of each other. This is how Sea's financials look, with left cash, equivalents and investments, and right the total debt.

As you can see (wink wink), Sea has a net cash position. This is a good financial position to be in. But I have high standards, especially considering debt, so I only give 7.5/10.

The negatives

I also have negative scores, that can subtract extra points from that score. The scores are marked out of 5 because a lot is already captured implicitly in the other numbers. The lower the score on these negative categories, the better, of course.

Risk 2.5/5

Last change November 2023

A lot is already baked in financial strength, but this is an overall risk score that shows more than just financial risk.

For Sea, I gave 2.5/5. More competition means more risk. It still has a cash cow in Garena, but gaming is not the most stable of businesses. The company has shown, though, that both Shopee and SeaMoney can be profitable too, reducing the risk.

Competition 3/5

Changed July 2024

How strong is the competition? Again, you can't objectively measure that but there are indications.

I lowered the score from 4/5 to 3/5. Gaming is very competitive, of course, but e-commerce even more, especially if you are fighting TikTok, Alibaba's Lazada, GoTo, the merger of Tokopedia and Gojek, Mercado Libre (in Brazil) and many others. But Sea/Shopee showed again that it is a very strong player and it took market share and grew more than 30% year-on-year, which is very impressive in a market with so much competition. That's why I lowered this negative score.

Dilution 1.5/5

I used to call this SBC (stock-based compensation) but dilution is a better term, as it is broader. Dilution is negative over the long run but that doesn't mean that companies should not issue stock when they are still growing fast. Look at Apple's shares outstanding before 2012, when it started buying back shares:

Data by YCharts

At the same time, I don't want to ignore dilution completely, so I give a negative score.

We look at this over a 3-year period to exclude missing something.

If we look at the last two years, ignoring that stock offering, you see that the dilution is actually pretty low.

Scale Advantages Shared 2.5/5

Since Q3 2023

I introduced this concept in this article. When I looked back at some of the best investments, they did not only have substantial scale advantages, but also shared them with their customers in some way. For Amazon or Walmart (at the time), I think this criterion is obvious. Because they are bigger, they can give their customers better prices.

Google has always had a scale advantage: the more people used their products, the more they could give away for free. The data of people were leveraged to generate profits for Google, but the fact that Google could offer so much for free (Gmail, Fotos, Drive storage up to a certain limit, etc.) was because of this mechanism.

I have not come up with this concept myself. This is one that I borrow from Nick Sleep from Nomad Capital. He uses this concept to guide all of his investments. That's why he started investing in Amazon in 2003 already. And he mostly held on to that position to now. He did the same thing with Costco, another company that shares the advantages of its scale with its customers, by only charging 15% on the purchase price, no matter what. This makes these companies almost impossible to compete with unless you start doing exactly the same thing.

The most prominent advocate of this? Jeff Bezos, who made this napkin sketch about it.

So, this competitive advantage can be significant. I'm going to withdraw or add points with this criterion. For some companies, extra scale only adds extra complexity. Those will get a negative score. I think of Uber (UBER) here. The normal scaling is the second level, which will be given some points. This means that if you grow, your scale gives you cost advantages. The third level is where all users also benefit from the scale. Here you will see higher scores, 4/5, maybe 5/5.

For a long time, Shopee showed excellent Scale Advantages shared, but Sea scaled back on those, as it needed to focus on profits by charging merchants more and reducing the discounts. That's why I lowered this score substantially, from 5 to 2.5/5.

Conclusion PM Quality Score

Sea's Potential Multibaggers Quality Score goes up from 61 to 67. That's great to see. Overall, this is a good score.

You can always look at the overview of the Overall Quality Scores here.

But of course, we want to know if Sea is an attractive stock to buy at these levels. Therefore, we need the QPI score.

The QPI Score

Valuation 8/10

Last change in July 2024

I think Sea is now between high growth and mature growth, because of its profitability.

The valuation score was high, with 9/10 when the stock traded at $35. It now trades at $68.76. Let's see how the valuation is right now.

For younger companies, the Price/Gross Profit often shows their potential. You can see that Sea's has gone up quite a bit compared to a few months ago.

As you can see, the stock now trades at 6.7 times gross profits. If you look at the past, you can see that this is still low, though.

If we look at forward metrics, this is the picture.

With a price/operational cash flow of 22, you can't say Sea is dirt cheap. The forward EV/EBITDA of 20 looks a bit better. The forward PE stands at 26.4, reasonable, but the forward P/FCF at 41, looks expensive. That means a mixed picture.

How about the 2024 and 2025 PEG ratios?

We are looking at a 2024 PE of 34.7. With 46% expected EPS growth, that means 2024 PEG of 0.75. For the 2025, with a PE of 18.4 and expected EPS growth of 88.6%, that means a 2025 PEG of just 0.21, which is very low.

Just to remind you, a PEG between 1 and 2 is fair, below 1 is cheap, above 2 expensive. Of course, with forward PEGs, there's higher uncertainty, as you have to believe the estimates.

We have to be careful with the forward numbers, of course. The company's management has demonstrated that they want to invest in their market leadership for Shopee. That could lower the earnings, of course. Sea regularly misses on EPS. But even if this is directionally right, the stock looks cheap based on this.

When I looked at the valuation in November 2023, this is what I wrote:

Overall, I think Sea is between undervalued and deeply undervalued, but the uncertainty is very high when it comes to the valuation.

With the stock almost 100% higher now, I think the stock is still undervalued compared to its growth profile. That's why my valuation score is 8/10 at this point.

With a PMQS of 67 and a Valuation Score of 8, Sea gets a QPI score of 14.7, up from 13.6. That warrants a buy on the BHS or Buy-Hold-Sell scale.

Sea remains a long-term investment about which I am not worried at this moment. The company is still early in its lifecycle. Don’t forget that it has not even been in e-commerce for 10 years. Of course, it spoiled its investors with very high growth during the pandemic but that doesn't mean that there is no bright future for Sea.

In the meantime, keep growing!