Chinese search-engine star Baidu (Nasdaq: BIDU ) closed at an all-time high yesterday. You won't see me complaining. The stock has soared 222% since I recommended it to Rule Breakers subscribers 11 months ago.
However, that kind of meteoric rise is enough to leave even a voracious momentum investor wondering whether the shares have gone too far, too soon.
Running the most popular website in the world's most populous nation will always draw a crowd, but infinity is never an option on the ticker tape.
Baidu went public two years ago, sporting a market cap of less than $1 billion at its $27 IPO price tag. After a nearly tenfold advance, Baidu is valued at more than a hearty $9 billion. Too much? Not enough?
Let's see whether we can find some sanity within the mania.
Behind the music
Yesterday's close of $268.79 is impressive, especially for a stock that dipped into the double digits back in April. Baidu's prospects haven't necessarily tripled over the past five months. Understanding why investors have warmed to China's market darling is important in assessing its future.
Why exactly have investors flocked to Baidu? Something important happened in the second quarter. Wall Street has always fancied the high-margin ways of search-engine leaders. The ability to convert traffic into profits is a breeze for search engines, because advertisers know that Web users hit a portal only when they want to go somewhere else.
Chinese content websites like Sohu.com (Nasdaq: SOHU ) , SINA (Nasdaq: SINA ) , NetEase.com (Nasdaq: NTES ) , and CDC's (Nasdaq: CHINA ) China.com are growing their online ad dollars, but the real money is going to Baidu, with its huge base of 128,000 advertisers.
However, the second-quarter event that triggered the market's interest in Baidu wasn't necessarily the company's own blowout quarter. That helped, of course, but more importantly, the good news came just days after Yahoo! (Nasdaq: YHOO ) posted flat earnings growth and Google (Nasdaq: GOOG ) actually missed analyst targets for the second time in its brief public tenure.
This forced search-engine investors to curb their enthusiasm for domestic giants, turning their attention to China's top dog. And Baidu certainly deserves the attention. Revenue more than doubled this past quarter, with earnings soaring 143%. Baidu now commands nearly two-thirds of China's search-engine market.
Baidu is obviously not putting up the same kind of numbers as Google. It's still too early in China's growth cycle for that to happen. The economy is growing at a torrid pace, and with it the budgets of advertisers trying to reach Chinese consumers, but Internet adoption rates are still a fraction of the usage that you find domestically.
Still, Baidu at $9 billion doesn't seem so tall when it's stacked against Google's $167 billion market cap, even though Baidu is still trading at loftier multiples.
View to a thrill
Analysts have been jacking Baidu's profit estimates higher ever since the company went public. Over the last three months alone, the pros have gone from expecting Baidu to earn $3.07 a share next year to $3.67 per share.
Even with the spike, Baidu is trading at an ambitious 73 times next year's earnings. However, you have to feel sorry for investors who cashed out at $92.80 back in April, not knowing that they were selling out at what would only be 25 times next year's bottom line projection -- and falling.
Baidu realizes that it needs to grow quickly to justify the market premiums. That explains the company's recent foray into the competitive Japanese search-engine market. It also explains the company's new move into offering video ads. Even if only a fraction of its 128,000 advertisers have the resources or desires to launch clip campaigns, it's an incremental win for Baidu if it succeeds.
Role-playing
So am I bailing on Baidu as a Rule Breakers pick? No way. I'm as hesitant as the next investor to chase it at this point, but I've seen way too many investors get burned by dumping their shares early. Since last night's close exactly equals Baidu's all-time high, everyone who ever bailed on the company has officially gotten scorched.
In a few weeks, things will really get interesting when Google, Yahoo!, and Baidu post their third-quarter results. Over the past few years, we've seen investors trade in their shares of Yahoo! for the more potent Google. If Google disappoints again -- and Baidu blows away the pros again -- isn't this really just a role-playing exercise, with Baidu being the new Google and Google being the new Yahoo!?
Even if Baidu takes a breather on the trading floor, it's hard to bet against a leader while it's still leading.
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