diff --git a/mercurial/manifest.py b/mercurial/manifest.py
--- a/mercurial/manifest.py
+++ b/mercurial/manifest.py
@@ -11,8 +11,7 @@ import array, struct
 
 propertycache = util.propertycache
 
-def _parse(data):
-    """Generates (path, node, flags) tuples from a manifest text"""
+def _parsev1(data):
     # This method does a little bit of excessive-looking
     # precondition checking. This is so that the behavior of this
     # class exactly matches its C counterpart to try and help
@@ -31,6 +30,34 @@ def _parse(data):
         else:
             yield f, revlog.bin(n), ''
 
+def _parsev2(data):
+    metadataend = data.find('\n')
+    # Just ignore metadata for now
+    pos = metadataend + 1
+    prevf = ''
+    while pos < len(data):
+        end = data.find('\n', pos + 1) # +1 to skip stem length byte
+        if end == -1:
+            raise ValueError('Manifest ended with incomplete file entry.')
+        stemlen = ord(data[pos])
+        items = data[pos + 1:end].split('\0')
+        f = prevf[:stemlen] + items[0]
+        if prevf > f:
+            raise ValueError('Manifest entries not in sorted order.')
+        fl = items[1]
+        # Just ignore metadata (items[2:] for now)
+        n = data[end + 1:end + 21]
+        yield f, n, fl
+        pos = end + 22
+        prevf = f
+
+def _parse(data):
+    """Generates (path, node, flags) tuples from a manifest text"""
+    if data.startswith('\0'):
+        return iter(_parsev2(data))
+    else:
+        return iter(_parsev1(data))
+
 def _text(it):
     """Given an iterator over (path, node, flags) tuples, returns a manifest
     text"""
@@ -116,7 +143,13 @@ except AttributeError:
 
 class manifestdict(object):
     def __init__(self, data=''):
-        self._lm = _lazymanifest(data)
+        if data.startswith('\0'):
+            #_lazymanifest can not parse v2
+            self._lm = _lazymanifest('')
+            for f, n, fl in _parsev2(data):
+                self._lm[f] = n, fl
+        else:
+            self._lm = _lazymanifest(data)
 
     def __getitem__(self, key):
         return self._lm[key][0]
diff --git a/tests/test-manifest.py b/tests/test-manifest.py
--- a/tests/test-manifest.py
+++ b/tests/test-manifest.py
@@ -8,6 +8,7 @@ from mercurial import manifest as manife
 from mercurial import match as matchmod
 
 EMTPY_MANIFEST = ''
+EMTPY_MANIFEST_V2 = '\0\n'
 
 HASH_1 = '1' * 40
 BIN_HASH_1 = binascii.unhexlify(HASH_1)
@@ -24,6 +25,42 @@ A_SHORT_MANIFEST = (
          'flag2': 'l',
          }
 
+# Same data as A_SHORT_MANIFEST
+A_SHORT_MANIFEST_V2 = (
+    '\0\n'
+    '\x00bar/baz/qux.py\0%(flag2)s\n%(hash2)s\n'
+    '\x00foo\0%(flag1)s\n%(hash1)s\n'
+    ) % {'hash1': BIN_HASH_1,
+         'flag1': '',
+         'hash2': BIN_HASH_2,
+         'flag2': 'l',
+         }
+
+# Same data as A_SHORT_MANIFEST
+A_METADATA_MANIFEST = (
+    '\0foo\0bar\n'
+    '\x00bar/baz/qux.py\0%(flag2)s\0foo\0bar\n%(hash2)s\n' # flag and metadata
+    '\x00foo\0%(flag1)s\0foo\n%(hash1)s\n' # no flag, but metadata
+    ) % {'hash1': BIN_HASH_1,
+         'flag1': '',
+         'hash2': BIN_HASH_2,
+         'flag2': 'l',
+         }
+
+A_STEM_COMPRESSED_MANIFEST = (
+    '\0\n'
+    '\x00bar/baz/qux.py\0%(flag2)s\n%(hash2)s\n'
+    '\x04qux/foo.py\0%(flag1)s\n%(hash1)s\n' # simple case of 4 stem chars
+    '\x0az.py\0%(flag1)s\n%(hash1)s\n' # tricky newline = 10 stem characters
+    '\x00%(verylongdir)sx/x\0\n%(hash1)s\n'
+    '\xffx/y\0\n%(hash2)s\n' # more than 255 stem chars
+    ) % {'hash1': BIN_HASH_1,
+         'flag1': '',
+         'hash2': BIN_HASH_2,
+         'flag2': 'l',
+         'verylongdir': 255 * 'x',
+         }
+
 A_DEEPER_MANIFEST = (
     'a/b/c/bar.py\0%(hash3)s%(flag1)s\n'
     'a/b/c/bar.txt\0%(hash1)s%(flag1)s\n'
@@ -77,6 +114,11 @@ class testmanifest(unittest.TestCase):
         self.assertEqual(0, len(m))
         self.assertEqual([], list(m))
 
+    def testEmptyManifestv2(self):
+        m = parsemanifest(EMTPY_MANIFEST_V2)
+        self.assertEqual(0, len(m))
+        self.assertEqual([], list(m))
+
     def testManifest(self):
         m = parsemanifest(A_SHORT_MANIFEST)
         self.assertEqual(['bar/baz/qux.py', 'foo'], list(m))
@@ -86,6 +128,25 @@ class testmanifest(unittest.TestCase):
         self.assertEqual('', m.flags('foo'))
         self.assertRaises(KeyError, lambda : m['wat'])
 
+    def testParseManifestV2(self):
+        m1 = parsemanifest(A_SHORT_MANIFEST)
+        m2 = parsemanifest(A_SHORT_MANIFEST_V2)
+        # Should have same content as A_SHORT_MANIFEST
+        self.assertEqual(m1.text(), m2.text())
+
+    def testParseManifestMetadata(self):
+        # Metadata is for future-proofing and should be accepted but ignored
+        m = parsemanifest(A_METADATA_MANIFEST)
+        self.assertEqual(A_SHORT_MANIFEST, m.text())
+
+    def testParseManifestStemCompression(self):
+        m = parsemanifest(A_STEM_COMPRESSED_MANIFEST)
+        self.assertIn('bar/baz/qux.py', m)
+        self.assertIn('bar/qux/foo.py', m)
+        self.assertIn('bar/qux/foz.py', m)
+        self.assertIn(256 * 'x' + '/x', m)
+        self.assertIn(256 * 'x' + '/y', m)
+
     def testSetItem(self):
         want = BIN_HASH_1