Is It Too Late to Buy Baidu Stock?

Baidu's (BIDU 0.72%) stock price is up about 40% this year. Most of the Chinese tech giant's rally was driven by two factors: the relaxation of China's zero-COVID restrictions, which should reduce the macroeconomic pressure on its advertising and cloud businesses, and a stampede toward all AI-related stocks, which was initially sparked by OpenAI's ChatGPT.

But is it too late to buy Baidu after those big gains? Let's see if its stock has gotten ahead of its business.

Image source: Getty Images.

What happened to Baidu over the past year?

Baidu owns the largest online search engine in China. That core business, along with its associated portals and apps, generates most of its revenue by selling online ads and other marketing services. In the third quarter of 2022, Baidu generated 57% of its revenue from its online marketing business. Another 23% came from its majority stake in iQiyi (IQ), one of the top streaming video platforms in China, while the remaining 20% came from its non-online marketing businesses (including its cloud platform). Baidu collectively refers to its AI and cloud businesses as the "AI Cloud."

Here's how those three core businesses fared over the past year:

Data source: Baidu. YOY = Year over year.

Baidu's online marketing revenue declined for two reasons: China's economic growth cooled off amid the unpredictable COVID-19 lockdowns, and it faced intense competition from Tencent's WeChat, ByteDance's Douyin (known as TikTok overseas), and other popular advertising platforms. iQiyi also struggled to gain new subscribers.

Baidu's non-online marketing revenue continued to climb, but its growth still cooled off as the macro headwinds forced companies to rein in their spending on big cloud and AI-related upgrades. Baidu's AI Cloud still remains a distant underdog in China's cloud infrastructure race, with a 9% share in the third quarter of 2022, according to Canalys.

That puts it in fourth place behind Alibaba Cloud (36%), Huawei Cloud (19%), and Tencent Cloud (16%). Baidu also admits that the AI Cloud is still deeply unprofitable -- but its operating losses are gradually narrowing.

Separate the market hype from reality

Baidu didn't provide any guidance last quarter, but CEO Robin Li predicted that its core businesses "should move in a positive direction over the next few quarters" as the country's COVID-19 restrictions are relaxed. Analysts expect its revenue and earnings to grow 5% and 15%, respectively, in 2022. For 2023, they expect its revenue and earnings to both rise about 10%. That outlook is stable, but it probably doesn't justify its year-to-date rally of 40%.

The COVID-19 headwinds might be dissipating in China, but Baidu still hasn't proven that it can keep pace with WeChat, which bundles together various search, news, messaging, gaming, and e-commerce features, or Douyin, which is disrupting legacy platforms (like Baidu) with its short videos.

As for Baidu's AI Cloud, it's still a loss-leading business that will continue to focus on launching new services -- like robotaxis and its upcoming "ERNIE" (Enhanced Representation through Knowledge Integration) chatbot -- instead of generating sustainable revenue for the foreseeable future.

Just as Microsoft is integrating ChatGPT into its own search and cloud capabilities, Baidu could eventually weave ERNIE into its core services. That could certainly widen Baidu's moat against Tencent and ByteDance, but investors shouldn't count those eggs before they hatch. They should also recall that Baidu actually launched ERNIE as an AI-powered language model back in 2019, so this sudden "chatbot" transformation seems like an attempt to capitalize on the recent ChatGPT hype.

Baidu's stock is still cheap -- for obvious reasons

Baidu's stock still trades at 16 times forward earnings after its recent rally. It might seem cheap, but it's trading at that discount because its near-term prospects are still murky. The recent headlines might continue to lift Baidu's stock in tandem with other Chinese tech and AI stocks, but its longer-term gains will be limited until its core businesses actually improve.

I believe it's a bit too late to buy Baidu's stock for now, since it's already gotten too far ahead of its actual business.