Born on the Baidu

It's good to be Baidu.com (Nasdaq: BIDU  ) . Analysts had set the bar high, expecting China's leading search engine to grow its fourth-quarter profits 255% higher. Instead, Baidu blew past them as profits soared fivefold to claim $0.45 a share.

Revenues grew 136% higher, in line with expectations. How can Wall Street get it so right on the top line and totally blow it on the bottom line? The pros simply didn't give Baidu enough room for the amazing margin expansion that many Chinese companies are using to dazzle investors.

Net margins for Baidu clocked in at a jaw-dropping 45.1% for the period. It's pretty amazing what a series of factors like affordable labor, corporate-friendly taxation, and the general high-margin nature of Internet ventures can do. As well as Baidu is doing, online gaming giant NetEase (Nasdaq: NTES  ) has clocked in with quarterly net profit margins as high as 58% in the past.

The Baidu success story is old news by now. We already know that nearly two-thirds of searches in the world's most populous nation are going through Baidu. Google (Nasdaq: GOOG  ) has actually lost market share in the area over the past year.

In a worthwhile investing lesson, this actually marks the first time that Baidu is trading for less than 100 times trailing earnings (even if it's just by a smidgen). Did the stock crater? No. It has more than quadrupled since its $27 IPO in the summer of 2005. However, earnings have grown even faster. In other words, even high-P/E stocks can be cheap in retrospect.

Credibility has called shotgun for this high-octane road trip. In the past quarter alone, Baidu has brokered deals with Microsoft (Nasdaq: MSFT  ) , Viacom (NYSE: VIA  ) , and EMI.

With just a tenth of China's citizenry online and the company targeting Japan for expansion later this year, growth should continue. Growing at a fraction of its explosive pace of profitability should still be enough to beat the market several times over, while giving value hounds some lower P/E ratios to justify. Is it any wonder Baidu was tapped as a Rule Breakers newsletter pick last year?

Shares have soared 38% higher since being singled out in the growth-stock service just four months ago. Baidu's penchant for clearing analyst targets in all but one quarter as a public company should keep the gains coming.

NetEase and Baidu are Rule Breakers newsletter recommendations. Where will the stock newsletter turn to next? Next week's new issue features two more picks, so sign up for your free 30-day trial now.

Microsoft is an Inside Value pick.

Longtime Fool contributor Rick Munarriz has recommended both NetEase and Baidu to newsletter subscribers, and both stocks have gone on to beat the market. He does not own shares in any of the companies mentioned in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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