Sea Shares Are Climbing Today - Are They Overvalued?

Internet Retail company Sea is standing out today, surging to $52.89 and marking a 8.1% change. In comparison the S&P 500 moved only 1.8%. SE is -43.15% below its average analyst target price of $93.04, which implies there is more upside for the stock. As such, the average analyst rates it at buy. Over the last year, Sea has underperfomed the S&P 500 by -57.4%, moving -78.2%.

Sea Limited, together with its subsidiaries, engages in the digital entertainment, e-commerce, and digital financial service businesses in Southeast Asia, Latin America, rest of Asia, and internationally. The company is a consumer cyclical company, whose sales and revenues correlate with periods of economic expansion and contraction. The reason behind this is that when the economy is growing, the average consumer has more money to spend on the discretionary (non necessary) products that cyclical consumer companies tend to offer. Consumer cyclical stocks may offer more growth potential than non-cyclical or defensive stocks, but at the expense of higher volatility.

Sea does not publish either its forward or trailing P/E ratios because their values are negative -- meaning that each share of stock represents a net earnings loss. But we can calculate these P/E ratios anyways using the stocks forward and trailing (Eps) values of $-2.11 and $-4.06. We can see that SE has a forward P/E ratio of -25.1 and a trailing P/E ratio of -13.0.

As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US consumer cyclical companies is 24.11, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

The main limitation with P/E ratios is that they don't take into account the growth of earnings. This means that a company with a higher than average P/E ratio may still be undervalued if it has high projected earnings growth. Conversely, a company with a low P/E ratio may not present a good value proposition if its projected earnings are stagnant.

When we divide Sea's P/E ratio by its projected 5 year earnings growth rate, we obtain its Price to Earnings Growth (PEG) ratio of 0.23. Since a PEG ratio of 1 or less may indicate that the company's valuation is proportionate to its growth potential, we see here that investors are undervaluing SE's growth potential .

To better understand the strength of Sea's business, we can analyse its operating margins, which are its revenues minus its operating costs. Consistently strong margins backed by a positive trend can signal that a company is on track to deliver returns for its shareholders. Here's the operating margin statistics for the last four years:

Date Reported Total Revenue ($ MM) Operating Expenses ($ MM) Operating Margins (%) YoY Growth (%)
2021-12-31 9,955 5,479 -15.9 46.63
2020-12-31 4,376 2,652 -29.79 27.29
2019-12-31 2,175 1,496 -40.97 65.74
2018-12-31 827 1,004 -119.57 n/a
  • Average operating margins: -51.6 %
  • Average operating margins growth rate: 46.6 %
  • Coefficient of variability (lower numbers indicate less volatility): 90.2 %

Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Sea's last four annual reports, we are able to obtain the following rundown of its free cash flow:

Date Reported Cash Flow from Operations ($ MM) Capital expenditures ($ MM) Free Cash Flow ($ MM) YoY Growth (%)
2021-12-31 209 -807 -599 -401.05
2020-12-31 556 -357 199 212.18
2019-12-31 70 -247 -177 73.69
2018-12-31 -495 -178 -674 n/a
  • Average free cash flow: $-312,662,750.00
  • Average free cash flown growth rate: -38.4 %
  • Coefficient of variability (the lower the better): 129.5 %

If it weren't negative, the free cash flow would represent the amount of money available for reinvestment in the business, or for payments to equity investors in the form of a dividend. While a negative cash flow for one or two quarters is not a sign of financial troubles for SE, a long term trend of negative or highly erratic cash flow levels may indicate a struggling business or a mismanaged company.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts.

Sea's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 6, so the company's assets may be overvalued compared to the average P/B ratio of the Consumer Cyclical sector, which stands at 3.11 as of the third quarter of 2022.

Sea is by most measures overvalued because it has a negative P/E ratio, an elevated P/B ratio, and irregular and negative cash flows with a downwards trend. The stock has strong growth indicators because it has a a PEG ratio of less than 1 and negative and irregular operating margins with a positive growth rate.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.