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Why NetEase Stock Plunged Today

What happened

Shares of Chinese internet and online-gaming company NetEase (NASDAQ: NTES) slumped on Thursday following a mixed second-quarter report. Revenue surged, but a profit shortfall and an analyst downgrade weighed on the stock. Shares of NetEase were down about 9% at 12:45 p.m. EDT.

So what

NetEase reported second-quarter revenue of $2.0 billion, up 49.4% year over year. Online game services revenue soared 46.5% to $1.4 billion, while email, e-commerce, and other revenue rose 68.9% to $494 million.

Advertising revenue increased 12.1% to $87.9 million. CEO William Ding explained that online games are the company's biggest opportunity:

While e-commerce is becoming an increasingly important revenue contributor, our self-developed mobile games remain our primary growth engine. During the second quarter, many legacy titles maintained their popularity, while our instant hit title Onmyoji had a natural ebb and flow. To bolster the power of this game's IP, we recently commenced dedicated brand expansion initiatives, and our international launch strategy is progressing well.

Image source: Getty Images.

Non-GAAP (generally accepted accounting principles) earnings per share came in at $3.86, up from $3.60 in the prior-year period but down from $4.82 in the first quarter. Analysts were expecting EPS of $4.02. The profit shortfall led CLSA to downgrade the stock to "underperform," citing a sequential slowdown in online games and the drag on margins created by e-commerce. Ding commented during the conference call that profitability was not the near-term focus for the e-commerce business.

Now what

Shares of NetEase have soared over the past five years, up about 430% in that time even after Thursday's plunge. NetEase is not a particularly cheap stock, trading for around 21 times earnings. The prospect of margin pressure due to the e-commerce business may be contributing to the sell-off.

Revenue and earnings have exploded along with the stock price, but after such a large gain over the past few years, the stock price may have pushed a little too far ahead of the fundamentals.

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Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of and recommends NetEase. The Motley Fool has a disclosure policy.