The rapid development of AI is profoundly impacting today's global business landscape. As technological visions become reality, capital market preferences have shifted from focusing on model capabilities to actual implementation. During the current earnings season, exceptional performance from versatile giants like Meta, Microsoft, and Google has confirmed the high prosperity of the AI sector. Beyond these, several players with strong growth potential have emerged in vertical sectors, among which NetEase Youdao (DAO.US) stands out as particularly representative, comprehensively integrating AI across its business lines through an "AI-native" strategy.

According to Youdao's recently disclosed second-quarter results, the company has maintained profitability for four consecutive quarters and achieved profitability in the second quarter for the first time in its history. The continued improvement in profit trends provides strong evidence for the effectiveness of Youdao's "AI-native" strategy.

Just a year ago, whether AI could actually help companies make money was still a highly debated topic. However, at the current juncture, whether from tech giants or vertical sector leaders like Youdao, disclosed financial reports all point to the same value signal—AI is beginning to generate cash flow.

Admittedly, AI companies' monetization paths each have their own focus, but they are clear enough. Take Youdao, for example—the company pragmatically focuses on high-value vertical scenarios such as education and advertising, where it excels and can relatively easily achieve monetization results, using a "vertical domain models + scenario penetration" approach to achieve profitability. This appears to be a reference path for vertical AI companies to achieve commercial breakthroughs.

**"Vertical Domain Models + Scenario Penetration" Profitability Path**

In the second quarter, by continuing to focus on core businesses, Youdao achieved total revenue of 1.42 billion yuan, a year-over-year increase of 7.2%. During the same period, Youdao's operating profit was 28.8 million yuan, maintaining profitability while achieving operating profit of 130 million yuan for the entire first half, a historical high.

Looking back at Youdao's profitability since 2023 across various half-year periods reveals two clear signals: First, the company's operating profit has been "stepping up" year by year, with this upward climbing trend becoming increasingly clear; second, the first half is Youdao's off-season, and in the previous two years' first halves, the company recorded negative operating profits, but this year's first half saw Youdao successfully achieve substantial profitability.

Reading between the lines, as the business peak season arrives in the second half, Youdao's profitability metrics are expected to rise sequentially and potentially reach new highs.

From a global perspective, vertical AI companies like NetEase Youdao, whose commercial value continues to be validated, are becoming increasingly common. Recently, leading online collaborative design platform Figma went public on US exchanges, with first-day closing gains as high as 250%. Behind the massive surge lies the underlying logic that markets recognize the irreplaceability of vertical AI applications—these applications can occupy users' mindshare through professional depth, thereby deepening their "moats."

To master professional depth essentially requires companies to have deep know-how accumulation in vertical scenarios. Youdao's know-how barriers in education and advertising fields are precisely the key to its ability to release powerful profit momentum in a short time.

Starting with the education scenario, over two thousand years ago, Confucius advocated "teaching according to students' aptitude." Confucius made this proposition because education is inherently individualized with no unified standards, which determines that general models cannot fully cover specific personalized needs. However, in the same scenario, companies that simultaneously master data, experience, and technology can precisely use software and hardware to embody AI as teachers who "better understand students," encapsulating technology as services to better achieve the goal of teaching according to aptitude.

Reflected in financial metrics, Youdao's learning services revenue reached 660 million yuan in the second quarter, with digital content services generating 450 million yuan in revenue. Behind this, Youdao Lingshi drove steady development across the entire business segment with robust growth of 30% year-over-year. Practical functions such as AI essay correction and AI college entrance exam volunteer guidance further boosted user retention rates to over 75%.

Beyond contributing incremental revenue, financial reports show this business has covered costs and operating expenses while generating considerable operating profit, further indicating that AI "cash generation" has entered a substantial phase.

In the advertising field, AI technology enhancement has similarly amplified advertising economic benefits. Taking global benchmark Meta as an example, the company's advertising revenue reached $46.5 billion in the second quarter, exceeding market expectations. According to statements by Meta founder, chairman, and CEO Zuckerberg during the earnings call, Meta's outstanding performance this quarter was mainly attributed to efficiency dividends released by AI in advertising systems.

Youdao's entry into the advertising industry actually began earlier than most people imagine. The company's advertising business originated from Youdao search technology and has nearly 20 years of history, witnessing the growth of Chinese internet advertising. Thanks to AI advancement, the advertising business has now developed into Youdao's "cash cow."

In the second quarter, Youdao's online marketing services segment achieved quarterly revenue of 630 million yuan, a year-over-year increase of 23.8%. For the advertising business, Youdao actively enhanced its full-chain AI transformation in the second quarter, with the landmark move being the launch of AI advertising optimization specialist "Youdao Xiaozhi."

According to introductions, this product is based on AI placement decision models and proprietary databases, achieving full-chain AI decision-making from demand analysis to effect tracking. As the product improves in the future, "Youdao Xiaozhi" is expected to autonomously complete all aspects around marketing objectives and achieve ideal delivery results, further improving advertising placement efficiency.

In terms of channels, Youdao maximizes its proximity advantages by deepening understanding of the gaming industry through NetEase Games, focusing on strengthening cooperation with NetEase Games and other game advertisers in domestic and international activities, establishing vertical advantages, then replicating to upstream and downstream segments. Through this strategy, Youdao's gaming advertising revenue grew over 50% year-over-year in Q2.

Nurtured by the group ecosystem, Youdao's advertising business growth potential is expected to continue releasing.

**"Moats" Behind Sustainable Profitability**

"The key to investing lies in determining a target company's competitive advantages, and especially importantly, determining the duration of these advantages. Product or service capabilities protected by broad, ever-flowing moats can bring investors rich returns," states the author in "The Little Book That Builds Wealth: The Knockout Formula for Finding Great Investments."

Entering the AI era, although rapidly changing innovative technologies are rewriting growth logic across industries, regardless of how technology evolves, "moats" remain the core element for judging a company's long-term investment value.

Currently, as profitability paths become increasingly clear, the time is ripe to re-examine Youdao's "moats." In summary, Youdao's measures to deepen its "moats" can be characterized as a "three-step approach" based on its "AI-native" strategy foundation.

Step one: Youdao seizes the era opportunity brought by increasingly mature reasoning models creating new opportunities for vertical industries, adopting a pragmatic approach of simultaneously "self-research and embracing open source." On one hand, it dynamically learns the world's most advanced large models and AI technologies; on the other hand, it quickly optimizes its self-developed Ziyue large model according to its business characteristics and needs, ensuring deployment flexibility.

Step two: In specific scenario selection, Youdao first anchors advantageous fields like education and advertising, then fully mobilizes its know-how accumulation while flexibly applying the latest AI technologies to continuously improve business capabilities and operational efficiency. For instance, in the second quarter, Youdao open-sourced the "Ziyue 3" mathematics model. With this model's enhancement, Youdao's Little P achieved mathematics problem-solving accuracy rates above 95% for K12 stages. Currently, "Ziyue 3" has achieved results surpassing numerous general models in a series of mathematical reasoning tasks.

Step three: Youdao innovatively encapsulates technology as services, allowing users to pay for implementable, quantifiable results rather than abstract technical concepts. Taking the education scenario as an example, as mentioned earlier, education has typical non-standardized characteristics. To better achieve the goal of teaching according to aptitude, Youdao has not devoted excessive energy to "computing power stacking" but instead invested more resources in scenario penetration, using a "product as scenario" philosophy through software and hardware to embody AI as teachers, thereby achieving better teaching results.

Worth mentioning here is that "software-hardware integration" has always been one of Youdao's important competitive advantages. Although Youdao actively reduced market investment in the second quarter to improve business health, causing temporary fluctuations in smart hardware business revenue, Youdao's leading position in this field remains prominent. To date, Youdao Dictionary Pen has won e-commerce platform sales championships for 6 consecutive years. Additionally, the new Youdao AI Q&A Pen, targeting high-frequency rigid demand scenarios like subject-specific tutoring, is in a sales climbing phase, with Q2 monthly average sales showing an 85% sequential increase.

Looking ahead, considering Youdao's comprehensive smart hardware product matrix, subsequent steady market development is expected to continue delivering on growth expectations in the hardware field.

In summary, under the guidance of its "AI-native" strategy, Youdao pragmatically focuses on high-margin fields where it excels. In terms of phased results, Youdao is advancing into a new stage of sustainable profitability.

Currently, the market still assigns Youdao a relatively low valuation, indicating that quite a few investors' understanding of Youdao may still be limited to viewing it merely as an education company, underestimating Youdao's commercial innovation and monetization potential using AI tools in education and advertising fields.

On the positive side, the greater the expectation gap in the stock market, the higher the potential returns. As AI's value in vertical applications continues to be released and Youdao's own profitability steadily materializes, market recognition of Youdao's growth potential is expected to update synchronously, at which point the company's value re-rating will begin to unfold.