Is Baidu the Comeback Stock of 2013?

The year 2012 was a rough one for Chinese search engine giant Baidu (NASDAQ: BIDU  ) . Shares underperformed the broader market by 30%, falling more than 16%, as the S&P 500 (SNPINDEX: ^GSPC  ) surged 13% for its best year since 2009. Concerns about increasing competition stalled a stock that had been crushing the market for years. 

It's a good thing for us that those concerns were wildly overblown. Baidu's stock is absolutely on sale right now, primed for an epic comeback in 2013. 

Why the market was worried
Back in August, a Chinese company called Qihoo 360 (NYSE: QIHU  ) , known for its Internet security and web browser, switched the default search engine on its widely-used browser from Baidu and Google (NASDAQ: GOOGL  ) to a newly-hatched search engine of its own. By December, the upstart Qihoo had almost 10% of China's search market. 

Investors had seen this sort of thing before. SINA  (NASDAQ: SINA  ) , the owner of Weibo, often referred to as "China's Twitter," started to feel the pain from new entrants in its market last year, as well; SINA's stock was accordingly pummeled in the process. The perpetrator? A company called Tencent, which developed a texting and voice messaging service called WeChat, in 2011. Despite Weibo's massive 400-million person user base, SINA's Chairman admitted that the rapidly growing WeChat was eating into Weibo's popularity. Since its highs last March, shares have suffered a brutal 35% decline. 

Of course, fears with SINA were probably compounded by the fact that the company has, you know, not been profitable recently, losing money in both 2010 and 2011. In fact, SINA will likely barely eke out a profit in 2012; analysts expect net income just over $25 million for the year, a far cry from the $411 million the company raked in back in 2009.

But Baidu isn't SINA, and Qihoo isn't Tencent. So, while Qihoo's rapid growth since entering the search market last August may appear eerily reminiscent to those familiar with the Chinese Internet scene, there are some compelling reasons to do away with that fallacious analogy. 

Why it shouldn't be
Let's briefly use the Socratic method to get to the brass tacks here: Is Baidu losing money? No. Have sales stopped growing? Not a chance! Is it still the most dominant search engine in one of the strongest, most rapid-growth economies in the world? You betcha.

Baidu has done what other Chinese Internet mainstays have been unable to do. Growing revenue, especially in today's breakneck Chinese economy, isn't an incredibly challenging task. But growing revenue while becoming more profitable is quite another prospect, and SINA isn't the only one that's struggled to do that

Consider Renren (NYSE: RENN  ) , a Chinese service similar to Facebook (NASDAQ: FB  ) here in the U.S. While revenue has grown at a prodigious rate -- from $14 million in 2008 to an estimated $175 million in 2012 -- Renren is still projected to lose money this year. 

What investors want to see isn't popularity -- it's profitability. And Baidu hasn't shied away from excelling in that area, growing both sales and earnings at a jaw-dropping pace. Thus we arrive at a convincing reason to believe Baidu's stock is unfeasibly cheap. Take a look at its recent growth rates compared to the ultimate search engine, Google. Then recall that Baidu actually trades for a lower multiple. Here's the sales growth:

Company 3 year avg 2011 2012 (proj.)
Google 24.1% 29.3% 42.8%
Baidu 55.8% 91.8% 53.9%

And the EPS growth:

Company 3 year avg 2011 2012 (proj.)
Google 18.2% 14.5% 11.3%
Baidu 74.4% 97.2% 57.6%

Sources: Motley Fool CAPS and Yahoo! Finance.

With this type of outsized growth, is there any reason Baidu should be trading at 19 times earnings to Google's 23 P/E multiple? I think not. Investors historically pony up the dough for higher growth and, with the momentum Baidu's business has, and the potential in the Chinese market, I tend to think they aren't ponying up enough.

After all, China has more than a billion people, and only about 40% of them have access to the Internet -- that's about half the 78% market penetration seen in the U.S. With Baidu hauling in more than 70% of the total paid search dollars in China, its definitive first-mover advantage will be tough for even Qihoo to usurp.

Keep in mind that much of Qihoo's rapid growth was due to that one-time change in its browser's search engine preferences. Qihoo can't do that again. And Google remains essentially out of the equation because of its problems with the Chinese government's excessive censorship.

All of these factors make the time seem right for a Baidu rally. With an established name, eye-popping growth, and a low multiple after some irrationally fearful selling in 2012, the coast is clear for Baidu to take off running this year. Our brand new premium report breaks down the dominant Chinese search provider's strengths and weaknesses so you can decide for yourself. Just click here to access it now.


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