Changyou.Com Ltd (ADR) (CYOU) Stock Is an Industry Laggard to Avoid

The Chinese internet sector has been red hot since the beginning of August, with the KraneShares CSI China Internet ETF (NASDAQ:KWEB) up 8% over the last six weeks. There are several stocks that could make for interesting opportunities here, but today I’d like to talk about one that hasn’t made the cut and should be approached with caution: Changyou.Com Ltd (ADR) (NASDAQ:CYOU).

CYOU is a Chinese developer and operator of online games, and while it has exposure to two of my favorite next-gen sectors — eSports and emerging markets e-commerce — Changyou has failed to join in the latest rally, instead dropping more than 4% since the beginning of August.

The reason for the underperformance in CYOU stock can be pinpointed to the company’s second-quarter earnings report at the end of July. Both the top- and bottom-lines came in well ahead of what even the most bullish analyst had predicted, but management provided forward third-quarter guidance that was worse than anticipated. Changyou is looking for revenue of $160-$170 million, below expectations of $191 million, on earnings of $1.02-$1.12 a share, also missing estimates of $1.21 a share.

CYOU Stock: Too Many Red Flags

The above were the first two red flags that my three-pronged analysis process uncovered. The third issue is the company’s forecast for online gaming revenue, which makes up about 75% of its total sales. Management expects online gaming revenue of $120-$130 million in the third quarter, which isn’t a big change from the $122.4 million reported in the second quarter.

This is the perfect example of why it’s extremely important to have a strategy in place when it comes to picking stocks. Just because a sector as a whole is performing well doesn’t mean that every stock within that group is an automatic buy. You cannot throw darts when it comes to investing; you need to look under the hood to get the real story of what’s going on.

Given CYOU’s lack of movement as the industry breaks out and guidance for the third quarter, I would not look to buy the stock at this time, especially with so many other attractive options available within this exciting niche sector. That said, I am not writing the company off completely and will be interested to see if it can turn things around next earnings season.

Matthew McCall is the founder and president of Penn Financial Group, an investment advisory firm, as well as the editor of FUTR Stocks and the ETF Bulletin. Matt just launched two new investment advisories focused around the “next” generation investing theme. His trademark three-prong investing approach targets the mega-trends old Wall Street is missing out on. Click here for more information on the “NexGen” Experience.

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