This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the worst...
From the looks of things, you'd think the results Baidu.com (Nasdaq: BIDU  ) reported this week were the very worst news imaginable. Just back from their Sandy-enforced vacation, Wall Streeters bid down the shares in a big way Wednesday -- subtracting 6% from Baidu's market cap in frenzied trading.

Not all investors think the news was so bad. While fellow Fool Rick Munarriz admitted to some disappointment in the company's Q3 growth rate, 50% revenue growth is still pretty impressive. It wasn't, however, quite impressive enough to prevent one of the biggest downgrades in recent memory -- a full 180-degree capitulation by Citigroup from "buy" to "sell," with a 50% cut in target price to boot.

Blasting Baidu for "weak mobile monetization" and a "slowdown of PC search revenues" to boot, Citi warned that there's more pain in store for investors as Baidu moves into Q4. Selling, general, and administrative expenses, are all expected to move higher, squeezing profit margins, as Baidu battles rivals Google (Nasdaq: GOOG  ) and Qihoo 360 (NYSE: QIHU  ) , leading to "higher traffic acquisition costs and more R&D expenses for the mobile and cloud computing transition."

Result: Citi further postulates that "Baidu's valuation could converge to Google's 15x" 2013 P/E ratio. In which case, the analyst fears we'll end next year with a share price of $95 or thereabouts -- a far cry from the $191 price target that the analyst had previously set for the stock.

Bye, bye, Baidu?
Coming on the heels of a revenue report that arguably "missed" expectations, Citi's downgrade has a lot of investors feeling nervous. (Witness yesterday's sell-off). But is this something you really need to worry about?

Maybe not.

Sure, on the one hand, if investors decide to give Baidu a Google-like valuation of 15 times forward earnings, that would be a big blow to Baidu's stock price. But why would anyone think 15 times earnings is appropriate for Baidu?

Consider: Right now, the consensus for long-term earnings growth at Google is a hair under 13.5% per year. Baidu, in contrast, is expected to grow upwards of 38% per year going forward. That's nearly three times as fast as Google. This company's going to have to put up some pretty miserable numbers -- numbers far worse than the 50% growth rate we saw this week -- before investors agree to cut their growth expectations by two-thirds.

Consider, too, the differences between the companies. Google gets nearly half of its revenues from the U.S., a country with a population of 312 million. Baidu, in contrast, serves a market of 1.34 billion, so it has a whole lot more revenue growth ahead of it. It's got more room for growth in market cap, too, before its $37 billion market cap approaches Google's heady $223 billion.

Valuation matters
Speaking of valuation, did I mention that Baidu today is just really, really cheap? It's not often you find a company pegged for 38% profits growth selling for a P/E ratio of just 24. (And with $3 billion of its market cap backed up by cold, hard net-of-debt cash, the valuation's arguably even cheaper than that).

Last but not least -- and perhaps Citigroup should have waited for this data to come in before making its bearish call on the stock -- China just reported that its manufacturing sector expanded in October for the first time in three months, signaling that "the world's second-biggest economy is rebounding after a seven-quarter slowdown."

Call me a rose-bespectacled optimist if you like, but all of this tells me that no matter what Citi says, Baidu's still a "buy." That's why, right now, right here, today, I'm challenging this megabanker to a public duel on Baidu. If Citi says "sell," I say "buy."

Who will be proven right in the end? Follow along on CAPS and find out.

Regardless of short-term fluctuations in the Chinese economy, we see great opportunity in Baidu (aka, the "Chinese Google") over the long term. Our brand-new premium report breaks down the dominant Chinese search provider's strengths and weaknesses. Just click here to access it now.

You can find Rich on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 301 out of more than 180,000 members. (For the record, Citi's CAPS rank is No. 4,134).

The Motley Fool owns shares of Baidu and Google. Motley Fool newsletter services recommend Baidu and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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