Better Buy: Baidu Inc (ADR) vs. Twitter Inc

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For most of the past eight years, popular technology stocks have been very richly valued. But today, we're investigating two companies whose stocks are actually quite affordable: Chinese search giant Baidu (BIDU +1.32%), and real-time social media platform Twitter (TWTR +0.00%).

Both of these companies have seen their stocks fall precipitously, down 36% and 74%, respectively, from their all-time highs. But which one is the better buy today? There's no way to definitively answer that question. But here are, what I consider, the three most important things to bear in mind to help you reach your own conclusion.

Financial fortitude

For growth investors, financial fortitude is frequently under-appreciated. That's because predictions for the future are often rose colored, and don't reflect potential problems that could arise.

When those issues do crop up, the company that has lots of cash on hand will have options: buying back its own stock, outspending rivals, or even making opportunistic acquisitions. Those under the burden of debt can't do any of that -- they just have to hope to survive the downturn.

Here's how Baidu and Twitter stack up in terms of financial fortitude.

Data source: Yahoo! Finance, SEC filings. Net income and free cash flow are on a trailing twelve-month basis.

It's important to note that Baidu is valued at over four times the market cap of Twitter. But even after we adjust for that, Baidu has superior net income and free cash flow. It also has a lot more cash on hand on an absolute basis.

That's important -- the company is already entering what could be a rough stretch after Chinese authorities tightened standards for online advertising, Baidu's primary revenue source.

While Twitter is certainly no slouch, Baidu has a lot more freedom given its robust free cash flows and pile of cash sitting in the bank.

Winner = Baidu

Sustainable competitive advantages

Since I started investing full-time in 2008, I've discovered that there's no variable more important than having a sustainable competitive advantage. It's what keeps competitors at bay, and allows a company's earnings to compound over the decades.

Baidu's competitive advantage is clear: it is far and away the leader in online search in China. China Internet Watch says that Baidu had an 80.8% market share as measured by advertising revenues in 2015. That's largely because it was a first-mover in online search, and the brand has become increasingly powerful.

Twitter, on the other hand, counts on one of the most powerful competitive advantages available: the network effect. With every user that joins Twitter, the platform becomes more attractive -- motivating others to sign up. It's a virtuous cycle.

Usually, I would give the nod here to Twitter, as I consider the network effect to be important. However, given that the company has struggled mightily to increase monthly active users on the site -- which shouldn't be a problem if the network effect is truly present -- I'm calling it a tie. If Twitter was able to accelerate user growth, the advantage would tilt toward the company.

Winner = Tie

Valuation

Now, let's deal with the variable I talked about at the outset. Both of these companies are well below their all time highs. While there's no perfect measure of value, here are four of my favorite.

Data source: Yahoo! Finance, Nasdaq.com, E*Trade. P/E is based on non-GAAP earnings.

At first glance, it would seem like Baidu is the obvious winner. It is only a third as expensive on a price-to-earnings basis, and five times cheaper on a price-to-free-cash-flow basis.

But this masks a couple of things: namely, that Twitter is spending a ton on innovation and infrastructure, and is just barely free cash flow positive -- which make it seem very expensive.

When we look at the company's PEG ratios -- which take into consideration the growth that lies ahead -- Twitter is actually trading at a steep discount to Baidu. That may even be exacerbated as analysts adjust their estimates in light of recent moves by the Chinese government.

Putting it all together, it makes the most sense to call this a tie.

Winner = Tie

As I hope you can see, both of these stocks are pretty good deals right now. Baidu ends up getting the nod because it is a more mature business. There's probably more upside to Twitter, but more risks as well. At the end of the day, you have to weigh those variables for yourself.