Dueling Fools: Baidu Bear

I'll admit, this duel is tough for me. As a colleague of Rick's on the Rule Breakers team, I'm hesitant to take shots at a member of our portfolio, especially once that's up more than 49% since the November issue.

Baidu.com (Nasdaq: BIDU  ) is a great growth story. China's economy is expanding roughly four times as fast as our own. And now there's news that 137 million people were online in the Sino superpower in 2006 -- up 23% from the year before. How do you argue with that?

Dodging the question ... for now
It's a good question, which I'll get back to.

First, let me say that while I won't tell you that Baidu is by-the-numbers overpriced -- I'm not a by-the-numbers value investor -- I strongly believe in relative valuation as described by New York University professor and Investment Fables author Aswath Damodaran. And that's where Baidu goes bad.

To recap, Damodaran argues that industry comparisons are worthless if you're comparing firms of different sizes and growth rates. That's what we have with Baidu and, say, Microsoft (Nasdaq: MSFT  ) . Comparing the two is irrelevant.

Take a moment to sun yourself
So, what's fair? I ran a screen at Capital IQ for firms valued at more than $4 billion, that traded on a U.S. exchange, and which, like Baidu, had at least doubled revenues over the past year. As expected, several not-so-cheap stocks turned up, including Sirius Satellite Radio (Nasdaq: SIRI  ) and Amylin Pharmaceuticals (Nasdaq: AMLN  ) .

But it was Rule Breakers portfolio teammate Suntech Power (NYSE: STP  ) -- a $5.4 billion company that's profitable, growing fast, and positioned at ground zero in the explosive solar-power industry -- that turned out to be the best comparison for Baidu.

Yet its stock is a lot cheaper:

Metric

Baidu

Suntech

EV to Revenue

45.55

10.95

Normalized P/E

250.83

91.50

Price-to-Book Value

31.17

10.25

Source: Capital IQ, a division of Standard & Poor's.

As are the stocks of Baidu's own industry rivals, Google (Nasdaq: GOOG  ) , Yahoo! (Nasdaq: YHOO  ) , and Microsoft:

Metric

Google

Yahoo!

Microsoft

EV to Revenue

14.98

5.92

5.97

Normalized P/E

66.87

54.74

26.27

Price-to-Book Value

10.74

8.17

9.57

Source: Capital IQ.

The George McFly of tech stocks
Alert Fools will notice that the problem with my argument is that it's inherently hypocritical. I've recommended expensive stocks before. Anyone else remember Akamai Technologies?

Here's the difference. When I picked Akamai, it was underpriced versus tech titans like Microsoft -- yet it too was dominant in its market, with patent protection.

Baidu, on the other hand, is widely understood and has no unassailable advantages. Search is too immature a technology. Programmers across the globe are working on ways to make the technology more intuitive. And private equity firms are pouring millions (maybe billions) into the effort. Every one of these projects is a threat to Baidu.

But investors know this. That's why even the suggestion of weakness has sent the stock running for cover faster than George McFly in Back to the Future. Check out this chart to see the stock's schizophrenia live and in color.

Don't let your portfolio get kung-powed
Back to the question at the open. How can you argue against a company that, for the moment, so thoroughly dominates its niche in a massively growing market? It takes guts. Which, interestingly, is also what the captain of our pirate ship, David Gardner, said when Rick picked Baidu.

Why? Because even David knew that there's a huge risk in holding the stock. He just happens to believe the risk is worth it.

David and Rick may end up being right. They have been thus far. But with technology moving as fast as it does, it's only a matter of time before a better search engine arrives. How long after you invest in Baidu will that be?

You're not quite done yet! To see the bull argument and the rebuttals, click here. If you've already read everything, cast your vote for the winner here.

Baidu is a recommendation of the Motley Fool Rule Breakers growth investing service. Ask for us a free all-access pass to get a closer look at all six stocks that have more than doubled since this market-beating portfolio began two years ago. Your pass is good for 30 days, and there's no obligation to subscribe.

Fool contributor Tim Beyers, ranked 762 out of more than 20,700 in Motley Fool CAPS, own shares of Akamai. Get the skinny on everything Tim is invested in by checking his Fool profile. You needn't search for disclosure at The Motley Fool.


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