I'm Buying This Chinese Small-Cap Stock

For more than two years, I've called out one or more stocks per month that I will be putting my real Roth IRA money into. Over that time frame, these picks have returned an average of 27%, which is beating the S&P 500 by 12 percentage points over the same time frame.

Today, I'm telling you why Dangdang , a player in China's e-commerce scene, will be my stock to buy for the month of September.

Positive momentum
My investing thesis is rather simple: I believe that current trends show that Dangdang is gaining traction with Chinese consumers -- having originally differentiated itself by focusing on books -- and it is spending money now in all the right areas to stay competitive in the future.

The company breaks down revenue into three categories: media (think e-books), general merchandise (stuff that's actually sent to your doorstep), and other (usually fulfillment services for third-party vendors). Over the last three-and-a-half years, revenue has jumped 51% per year!

Source: SEC filings.

As you can see, what started out as a predominantly media-focused business has expanded to selling just about anything. And though the margins might be lower, "anything" sales have been booming.

Another way to measure the company's popularity is via the number of active members it has, and how many orders those members are placing. The Internet age in China isn't in its infancy anymore, but it's still in the adolescent stage. As of May 2013, the Internet was available to approximately 42% of mainland China. Companies like Dangdang need to work hard to capture new Internet users as they come online.

As you can see below, since 2009, Dangdang has been able to grow active customers by 38% and total orders by 33% per year.

Source: SEC filings , all figures in millions.

Equally encouraging, between 2009 and 2012, the average revenue per active customer increased from about $37 per year to $53 per year.

Where's the profit?
One of the big red flags investors are worried about is that Dangdang's once-profitable business model has been in the red for more than two years now. Normally, this would be a cause for concern, but I think the business is actually doing the right thing by spending lots of money now.

The vast majority of Dangdang's jump in expenses has come in the form of building out fulfillment centers. These centers can be extremely expensive, but they represent a crucial advantage. By spreading fulfillment centers throughout China, Dangdang can get its products to customers' doorsteps much quicker. That's the kind of convenience that keeps customers coming back.

Currently, Dangdang has 20 logistics centers in 11 major Chinese cities with 4.5 million square feet of space. Just two years ago, there were centers in just five cities and only 1.9 million square feet of space. That growth helps put spending on these centers in perspective.

Source: SEC filings , all figures in millions.

Interestingly enough, during the most recent earnings report, the company announced that spending on fulfillment centers actually fell. This could mean Dangdang feels it has sufficient presence to meet customers' needs for the time being. If revenue growth continues on its current path, it will cancel out the increased spending of the past few years and could signal a return to profitability.

Lots of risks
It's somewhat humorous that Dangdang is referred to by some as the "Amazon of China." The e-commerce space is far more crowded in China than it is in the United States. And in reality, Amazon has a bigger slice of the Chinese e-commerce pie than Dangdang does.

But even these two pale in comparison to the Big Three e-commerce sites of Tmall (Alibaba), QQ Buy (Tencent), and Qihoo's 360 Buy, which have market shares of 42%, 28%, and 16%, respectively.

So why buy Dangdang when it has such a small presence? Simply put, it's clear that the business is growing, and Dangdang is doing what it can to remain relevant. The overall pie of Chinese commerce is growing so rapidly that any increase in market share means huge gains for smaller players like Dangdang.

And though it's tough to do an apples-to-apples comparison, consider that Amazon currently trades for about 1.9 times sales while Dangdang goes for 0.8 times sales. If investors were to buy Dangdang for a price equal to sales, it would represent an immediate jump of 25% in the stock.

As rosy as that looks, I want to make it clear that I'm putting less than 1% of my overall holdings behind Dangdang. I think it's shown positive business momentum, and it is worth my time to keep tabs on the stock.

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The article I'm Buying This Chinese Small-Cap Stock originally appeared on Fool.com.

Fool contributor Brian Stoffel owns shares of Amazon.com. The Motley Fool recommends and owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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