Tencent Holdings (NASDAQOTH: TCEHY) is already one of the world's largest companies. The Chinese tech and multimedia giant boasts a market cap north of $550 billion, and it's delivered impressive returns for shareholders who got in early. Tencent's share price has climbed roughly 4,000% from its market-close price on its IPO day back in 2005.
That means that $2,500 invested in the company roughly 13 years ago would be worth north of $100,000 today. Add another zero to your initial investment and your Tencent stock would be worth over $1 million. That's an incredible return in less than 15 years, but for new investors, the question is whether the stock still has big upside potential. I think the answer to the question is "yes," and here's why.
Continue Reading Below
A promising macro backdrop
In addition to its myriad business strengths, Tencent is on track to benefit from powerful growth that's shaping China's tech sector and the broader Chinese economy. Roughly 40% of the country's population has yet to connect to the internet, but urbanization is happening at a rapid pace, expanding access to the internet and spurring the growth of the middle class.
McKinsey estimates that annual disposable income for those in the Chinese middle class will have risen from about $4,000 in 2010 to $8,000 in 2020. That's only one part of the growth equation, however. Investment bank Credit Suisse estimates that the size of China's middle class will have grown by 850 million people from 2009 to 2030. These are trends that bode very well for Tencent, which provides products including social networks, online payment options, and entertainment and information platforms.
A well-oiled multimedia machine
One of the characteristics that I look for when identifying companies with great long-term growth potential is a high degree of synergy between business segments. If a company can derive a competitive advantage from the interplay among units, even a small one, that edge has the potential to become more pronounced with time. It's the type of advantage that can play a defining role in market position and stock returns. And Tencent has that kind of beneficial synergy in spades.
The company owns and operates WeChat, a messaging platform that has over 1 billion monthly active users and one that also acts as an all-in-one app. In addition to its messaging features, the service can be used for ride-hailing, ordering food, payment processing, and a wide range of other purposes. With a massive user base and far-reaching applications, WeChat benefits from its own network effect and extends this advantage to other Tencent businesses.
This synergy is evident in its gaming unit, with WeChat being tied into marquee titles and also serving as its own content platform. This advantage has helped Tencent rise to the top of the video game industry, with the company standing as the world's largest publisher by revenue and possessing a selection of franchise properties, development resources, and social media integration that position it to take advantage of ongoing growth in interactive entertainment.
Titles like League of Legends and Honor of Kings are hugely popular and rank among the world's most-played games. (Tencent created Honor of Kings and the company owns Riot Games, which is responsible for League of Legends.) These are titles with massive global audiences and long product life cycles that arm the company with high-margin revenue streams that last for years and become more profitable with time. Strength in the video game space also positions the company to take advantage of big growth opportunities in esports and mixed reality -- rising product categories that feed into expansion potential in social media and online payment services.
The tech giant has also built one of China's most successful video-streaming platforms -- an asset that adds to the theme of beneficial synergies between its products. For example, users might upload a League of Legends gameplay video, which might then be discussed through WeChat. That social media engagement is likely to feed attention back to the game, paving the way for more videos and online discussion. There are a variety of permutations for this type of relationship, and they're generally going to work in Tencent's favor and help the company continue on its stellar sales trajectory.
Diversified growth engines
Tencent is also ramping up its presence in the cloud services space, a development that's promising on multiple levels. The September-ended quarter saw revenue for its "other businesses" segment (which primarily consists of its cloud and payment processing units) climb 143% year over year to comprise 18% of total sales. Ramping up strength in the cloud is a move that's likely to create far-reaching benefits for the company's other businesses as well.
The cloud unit gives Tencent added resources for its artificial intelligence initiatives and a built-in and expanding customer base for AI features and services. Technologies developed within the cloud business could tie into the social media and gaming businesses, and vice versa, adding new dimensions to the synergistic loops already at play.
Tencent also owns a significant stake in a wide range of growth stocks. To give you a small snapshot of its portfolio, it owns roughly 5% of Activision Blizzard, 21% of JD.com, 5% of Tesla Motors, and 21% of Glu Mobile. That further diversifies the company and positions it to benefit from the growth of the overall tech sector.
A Fool's takeaway
Big expectations are factored into Tencent's stock price, with shares trading at 62 times trailing earnings and 18 times trailing sales, but the company has built a series of competitive advantages that position it to thrive over the long term. The stock's most explosive growth may be behind it, but it's not too late to get in on what still looks to be a very promising long-term trajectory.
10 stocks we like better than Tencent HoldingsWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Tencent Holdings wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of March 5, 2018