Chinese Net stocks to watch

NEW YORK (CNNMoney.com) -- The Nasdaq composite has lagged the blue-chip Dow Jones industrial average this year, but one tech sector that's seen huge gains is Chinese Internet stocks.

In recent years, investors have flocked to China. China's booming economy, which has consistently racked up double-digit growth, as well as its growing middle class have made it a nation not to be ignored.

Ctrip (yellow), Baidu (blue) and Sohu (green) are among the Chinese Net stocks that have surged this year.

Net stocks, in particular, have become attractive for investors eyeing the country's growing population of Internet users. China is home to some 123 million people who go online, according to the state-run China Internet Network Information Center.

But the dot.com bubble has taught investors not to load up solely on Internet stocks, and rightly so. Net stocks can be extremely speculative - and Chinese Internet stocks even more so, due to regulatory risks.

But for those willing to stomach the volatility, here are three stocks to watch in 2007.

2006 price change: 33%

Pros: As China's leading Internet portal, Sohu is benefiting from the surge in online advertising. Sohu (Charts) is especially well positioned to benefit from online advertising since it has inked a deal to become the official Internet sponsor for the 2008 Beijing Olympic Games.

With its long-term growth prospects, the company is also fairly reasonably priced, according to Ryan Jacob, portfolio manager of the Jacob Internet Fund, which owns the stock. Sohu trades at about 28 times analysts' estimated earnings for calendar 2007. That's a discount even to counterparts in the U.S. such as Yahoo (Charts), which trades at 45 times 2007 earnings.

Cons: Investors have taken a roller coaster ride on the stock, which traded below $1 in 2001 after the dot.com bubble burst.

2006 price change: 64%

Pros: The leader in search in China is one of the sector's fastest-growing companies. Earnings are expected to climb 87 percent from the year-ago period in 2007.

"It's been demonstrated that search is an important component to people's experience on the Web," said Kevin Landis, portfolio manager of Firsthand Capital Management, a mutual fund firm specializing in tech stocks.

His Firsthand e-Commerce Fund owns shares of Baidu (Charts) with the longer-term view in mind. "We're looking at five years from now, and the potential is huge," he said.

Cons: Baidu has one of the highest expected earnings growth rates - but it comes with a price to match. The company trades at a whopping 60 times estimated earnings for calendar 2007.

Furthermore, a battle is brewing with Google (Charts), which sold its small stake in Baidu earlier this year and is trying to expand its foothold in China.

2006 price change: 106%

Pros: The online travel agency sells airline and hotel reservations over the Web and through its call centers.

Besides steadily taking market share from traditional mom-and-pop travel shops, the online travel agency gives investors exposure to China's growing middle class - the fuel behind the country's economic expansion.

Cons: Ctrip (Charts) has solid fundamentals and strong momentum, but the valuation isn't very compelling, said C. Ming Zhao, an analyst at Susquehanna Financial Group.

Since it's a middleman in the airline industry, the company could face challenges down the road as airline carriers start selling tickets directly from their own sites, added Zhao, who has a "neutral" rating on the stock.

The Net's next phase