Have you thought about buying shares in China's search engine stock Baidu (Nasdaq:BIDU)? The stock has a P/E ratio ranging from 40 to 50 and has already doubled from $120 to $240 in a torrid run-up in less than six months. Baidu faces serious competitive pressures from U.S. giant Google (Nasdaq:GOOG) and fast-growing domestic competitor Sohu (Nasdaq:SOHU), along with the jittery nature of overseas equity markets. All this adds up to avoidance, or at least some caution - doesn't it? Maybe not.
Earnings, Earnings, Earnings
One thing that has always hammered away at any approach to fundamental investing is the long-term value of earnings. Whether you are a follower of Graham and Dodd via Buffett, or you have in your mind's eye Peter Lynch's books with their two-page charts of jagged ink lines of rising earnings over the years, you never lose sight of the main idea. That principle is that earnings are the underlying value of a stock, and over the long term the stock price should reflect the value of earnings. Baidu's first-quarter earnings report showed a 41.1% rise in revenue, with a 23.5% rise in income. Add to this Baidu's estimated long-term growth rate of around 33%, and you begin to see why this stock is attractive despite some otherwise daunting numbers. (For more on analyst estimates, be sure to read Analyst Forecasts Spell Disaster For Some Stocks.)
Growth Is The Game
Baidu will not continue to have growth without challenges. Google is one of them. Its giant footprint will no doubt deepen in China, yet the untapped market for China is still huge. Investors shouldn't think in terms of the more limited growth potential metrics of the U.S. and western Europe when assessing China. Sohu, ostensibly a Baidu and Google competitor, is growing at a healthy clip and developing diverse operations. There's room for Baidu, Google, Sohu and likely more.
Despite the heat of the stock run-up and the heady growth of business for Baidu, its management is running a steady, solid business that emphasizes controlling costs and expanding its markets. For example, it's creating new tiers of service levels such as its Phoenix Nest, which is an enhanced bidding platform for professional online marketers.
Google continues to develop new approaches in the U.S. that refine and coordinate many of its search tools with applications such as cell phones and other electronic devices. Real-time searches, "smart" searches and enhancements such as Google Squared will be in place soon. Analysts predict that Google will grow its share of the search market in China from 23% in 2008 to 33% in 2010, which will dampen Baidu's share from its now-held 59% to an estimated 51%, according to a Credit Suisse analyst. But that's assuming all the alliances, partnerships and plans go off without any return salvo in the search war from Baidu, which is unlikely.
More New And Old Players
While Baidu may be watching Sohu and Google closely, China web portal ad seller and internet service company Netease (Nasdaq:NTES) is a new cash cow on the scene. The company has one-half the debt ratio of Baidu and currently sells for 17 times earnings, so it is another player to watch. The future of internet development in China must be looked at in total, too. In the U.S. and internationally, such companies as Yahoo! (Nasdaq:YHOO) continue to grow offshoots to their original businesses. Yahoo - though not the most robust competitor with Google, for example, in internet advertising - is still involved there and always has the possibility of being acquired or morphing into other branches of the closely aligned search, advertising, internet and mobile communications world. So, too, might any of the main Chinese players. Baidu ultimately need not limit itself to search.
The Future Of Baidu
The full extent of Baidu spreading its tentacles throughout China and beyond is yet to be seen. Even today it is not limited to China, nor will its eventual growth be limited to China. And nothing says Baidu CEO Robin Li's management team won't make some future savvy alliances of its own, or partnerships in closely related businesses. Also, China companies have, if not a friend, at least a careful observer in their own government, which may be ready to give a strategic boost every now and then. While the Chinese/Hong Kong stock market may be somewhat overheated now that it's off the lows of last year, investors should consider Baidu stock on a pullback as a long-term buy in what will still be a surprisingly attractive market for many years.
For more, read Investing In China.