Chinese growth stocks have started to bounce back lately, but that tide isn't lifting all ships. Baidu (BIDU +0.88%) -- one of the country's original dot-com darlings -- has failed to bubble up to the surface. China's leading search engine hit a five-year low last month, and with its highest short interest in years, there are a lot of people betting on the stock not bouncing back.
There are certainly some good reasons for Baidu's swan dive. Baidu isn't at its best right now. However, a good argument could be made that one of China's biggest success stories -- the stock remains better than a 40-bagger since going public at a split-adjusted price of $2.70 in the summer of 2005 -- has gone from being a monster growth stock to a reasonable consideration for value investors. Let's size up Baidu's potential to beat the market from its current lull.
Image source: Baidu.
Riding the storm out
It's been a perfect storm for Baidu shareholders. China's slowing economy has smacked the online advertising industry, just as regulators have gotten more active in dictating internet content. The nature of online research has also evolved from the simplicity of the search bar, and it has all added up to dramatic deceleration in Baidu's flagship business. Baidu's online ad revenue slowed to a mere 3% uptick in its latest quarter, and the news isn't any prettier at the other end of its income statement.
A lot of Baidu's growth has come from deficit-saddled new initiatives and costly content plays. The end result is that the online giant posted its first quarterly operating loss as a public company last time out.
The disappointing first quarter isn't a fluke. Baidu's mid-May outlook for the quarter that ended last month calls for revenue from continuing operations to inch just 1% to 6% higher -- or flat on a reported basis.
Baidu seems to be doing a good job of scaring both camps of market strategists. Growth investors know that it's time to pitch a tent elsewhere when growth evaporates, and value investors don't take kindly to crumbling profitability. The important takeaway here is that analysts who follow Baidu and theoretically have a good read on its potential see things improving soon. Wall Street pros see Baidu returning to double-digit growth next year -- up 15% -- with an even bigger bounce on its depressed profitability. Baidu stock is currently trading at less than 17 times next year's projected earnings. Look out to 2021 and the multiple drops to 12.
Baidu's revenue-based valuations are also naturally at historic lows, as revenue has more than tripled since the last time that the shares are as low as they are now. It's fair to say that Baidu is this cheap for a reason, and its latest financial results are problematic. However, if analysts are right about its fundamentals starting to show signs of life in a few quarters, it's also easy to see the stock beating the market at this point. Baidu is not looking pretty right now, but it does look like an opportunistic buy at current levels.
