Youdao's Earnings Breakthrough and Buyback Potential: A Long-Term Investment Case

Youdao Inc. (NYSE: DAO) has emerged from a period of financial turbulence with a Q2 2025 earnings report that signals a strategic pivot toward profitability and AI-led innovation. For long-term investors, the question now is whether this turnaround justifies renewed confidence in the stock, particularly as the company navigates margin improvements, AI-driven revenue streams, and the potential resumption of its share buyback program.

Earnings Breakthrough: A Turnaround Driven by AI

Youdao's Q2 2025 results reflect a dramatic shift in its financial trajectory. Total net revenue rose 7.2% year-over-year to RMB1.4 billion ($197.9 million), driven by two key segments: learning services and online marketing. The learning services segment, bolstered by the AI Essay Grading feature in Youdao Lingshi, achieved a 2.2% revenue increase and a record-high user retention rate of over 75%. Meanwhile, online marketing services surged 23.8% to RMB632.9 million, fueled by AI-powered tools like the AI Ad Placement Optimizer and a 50% year-over-year jump in gaming advertising revenue.

The smart devices segment, however, remains a challenge, with revenue declining 23.9% to RMB126.8 million. This drop reflects broader consumer electronics market trends but is partially offset by margin improvements. The segment's gross margin rose to 41.5% in Q2, up from 30.3% in 2024, thanks to the launch of the Youdao Dictionary Pen and SpaceOne tutoring pen. These high-margin products demonstrate Youdao's ability to innovate even in a shrinking market.

Margin Expansion and Cost Discipline

Operating expenses fell 22.1% year-over-year to RMB580.6 million, driven by a 21.3% reduction in R&D costs and a 21.5% cut in marketing expenses. This cost discipline enabled Youdao to post its first positive operating income of RMB28.8 million in Q2 2025, reversing a RMB72.6 million loss in the same period in 2024. Non-GAAP net income attributable to shareholders reached RMB12.5 million, a stark contrast to a RMB96.0 million loss in 2024.

The company's gross margin of 43.0% in Q2, while down from 48.2% in 2024, still outperforms industry averages in the AI education and advertising sectors. Analysts attribute this to Youdao's focus on high-margin AI-driven services, such as subscription-based learning tools and performance-based advertising.

Buyback Resumption: A Signal of Confidence

Youdao's share repurchase program, authorized for up to $40 million, has already spent $33.8 million to repurchase 7.5 million ADSs as of June 30, 2025. While the Q2 earnings call did not explicitly mention new buyback authorizations, management emphasized a commitment to operating cash flow breakeven by year-end 2025 and a disciplined capital allocation strategy.

The company's liquidity position supports this ambition: cash and short-term investments totaled RMB617.0 million ($86.1 million), with additional financing from NetEase Group and Tencent. This financial flexibility, combined with a price-to-sales ratio of 0.48 (well below peers like Gaotu Techedu at 2.48), suggests Youdao is undervalued and could resume aggressive buybacks if cash flow improves further.

AI-Driven Growth: A Long-Term Catalyst

Youdao's AI-native strategy is the linchpin of its long-term potential. The launch of Confucius 3, its latest large language model, and the open-sourcing of Confucius 3-Math have solidified its technical leadership in AI education. The AI Essay Grading feature, now expanding to English essays, is projected to drive a 30% year-over-year revenue increase in learning services.

In advertising, Youdao's AI Ad Placement Optimizer and MagicBox ad creative suite have attracted high-margin clients in gaming and overseas markets. Gaming advertising revenue, for instance, grew 50% year-over-year, with partnerships with NetEase Games and global platforms like Google and TikTok expanding its reach.

Risks and Considerations

While the outlook is optimistic, investors should remain cautious. The smart devices segment's decline highlights vulnerability to macroeconomic shifts in consumer electronics. Additionally, Youdao's reliance on NetEase's financial support (via RMB878.0 million in short-term loans) introduces counterparty risk. Regulatory scrutiny in China's education sector could also impact growth in learning services.

Investment Thesis: A Buy for the Patient

For long-term investors, Youdao's Q2 results present a compelling case. The company has achieved operational breakeven, demonstrated AI-driven revenue growth, and maintained a strong liquidity position. Its share repurchase program, if resumed, could further enhance shareholder value.

Historical data from 2022 to 2025 reveals that DAO has shown a positive trend following earnings releases, with a 57.14% win rate over 3 days, 64.29% over 10 days, and 50% over 30 days. The maximum return during this period reached 8.03% on July 21, 2025, underscoring the stock's potential for short-term gains post-earnings. These patterns suggest that Youdao's strategic execution and AI innovation have historically translated into market confidence, reinforcing the case for a buy.

Key metrics to monitor:
- Operating cash flow breakeven by Q4 2025.
- AI subscription revenue growth in Q3 2025.
- Buyback activity in upcoming quarters.

Conclusion

Youdao's earnings breakthrough and AI-driven innovation have transformed it from a loss-making entity into a high-margin growth story. While risks persist, the company's strategic focus on profitability, cost discipline, and AI expansion positions it as a high-conviction buy for investors with a 3–5 year horizon. As Youdao continues to scale its AI infrastructure and enter new markets like Southeast Asia, the stock's current valuation offers an attractive entry point for those willing to ride the AI education and advertising wave.

Final Verdict: Buy for long-term growth, with a target price range of $9.63–$18.19 based on analyst consensus.