I'm sure most Baidu (Nasdaq: BIDU ) fans were grinning ear to ear last Tuesday when Internet trade portal Alibaba.com nearly tripled on its first day of trading, putting it at more than 320 times the company's 2007 forecast earnings. That kind of performance is sure to act as a vote of confidence for those trying to justify Baidu's outrageous valuation.
I can't blame people for getting hyped up about a stock like Baidu, one that has generated a triple of its own in the past 12 months. We're in the stock market to make money, right? Baidu has made people money over the past few years, and a lot of it. No doubt about that.
But, ahem, I need not remind you that we're only concerned with where a stock is going in the future, not what it has done in the past. It's sort of like why I don't care about what winning lottery numbers were picked last week. I just want to know what ones will be picked next week.
Save the hate mail
So will Baidu go any higher from here? It very well may. The Nasdaq boom went on for several years after Alan Greenspan declared "irrational exuberance." If you're into playing the corporate roulette wheel, go for it. Baidu won't be short of hair-raising moves anytime soon.
But let me answer a more simple question, one that us investors, not speculators, wish to know. Is Baidu actually worth more than $300 a share? Or $400 a share last week? What about $500?
I'll be blunt about it: It ain't.
Show me the money!
With a market-cap past $11 billion, and 2006 earnings of $38.7 million, you're more likely to find investment value out of a can of string beans. The current price represents almost a 300 price-to-earnings multiple over 2006 earnings -- but I won't be too hypocritical -- what counts is what they will earn in the future. Now I'm not Nostradamus, so any thoughts about future earnings are purely hypothetical. Baidu has, however, been affectionately referred to as "The Google (Nasdaq: GOOG ) of China." Whether that's true has yet to be determined, but for simplicity, I'll assume that Baidu achieves the same growth over the next three years that Google did over the past three years.
From 2004 through 2006, Google increased its net income about 7.5 times over, which equates to an otherworldly annualized growth rate of about 95%! Shareholders have been rewarded handsomely with at least a 7-bagger if they currently held shares from the 2004 debut.
So what if Baidu achieves the same amount of prosperity? Before you fire back with the "China is so big, Baidu is going to take over the world" comments, keep in mind that the company operates in a country with very tight Internet restrictions, something Google hasn't had to deal with in the United States. Regardless, I'll assume Baidu achieves the same 7.5-fold gain in net income over the next three years and then holds on to Google's current trailing P/E ratio of 50. What would Baidu look like then?
That's it?
Drum roll, please ... about $425 per share, for a total return of around 9% a year over the next three years. And remember, that's assuming Baidu achieves the same bottom-line performance as Google, one of the world's most admired and respected corporations. There are, of course, several other outcomes that could occur. Baidu could lose market share to its competitors -- Google is not only gaining in the Chinese market but is also striking deals with popular Web portals such as SINA (Nasdaq: SINA ) and CDC's (Nasdaq: CHINA ) China.com. Or what if China's search market doesn't grow quickly enough to pole vault over Baidu's growth expectations? By sheer popularity alone, it appears that nobody is taking these factors into consideration.
If you claim to be an investor, there is absolutely no room for error in Baidu, yet there's an incredible amount of downside risk if the stars don't all align. We've seen this before. Remember the tech bubble and what happened to the shares of high-flying Internet stocks like Yahoo! (Nasdaq: YHOO ) and CNET (Nasdaq: CNET ) ? Or the correction in Heelys' (Nasdaq: HLYS ) stock price this summer. These are examples of companies with lofty expectations built into the share price that ended up leaving shareholders in the dust.
Following the crowd and jumping on the Baidu bandwagon now might leave you kicking yourself in the short run, but that isn't what true investing is about. Baidu has reached a supreme mark of optimism, a sign that every bit of good news that could come in the future has already shown up in the stock price. And if even the slightest whisper of bad news arises, shares could be heading for the exits before you know it.
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