Investing in Chinese companies has been a pastime fraught with danger. Not only does the average retail investor not have access to the physical products many of these companies produce, but there have been countless instances of fraud from the Middle Kingdom.
That's tough for American investors to cope with, since most of us wouldn't mind a piece of the world's fastest-growing large economy. Luckily, a select few Chinese companies are large enough, and respected enough, that we can put our hard-earned money behind them. One such company is Baidu (NASDAQ:BIDU), the parent company of China's largest search engine.
So far in 2014, the stock is up about 20%. But to really understand Baidu's most recent movements, we need to start our timeline in early April, when the company reached its 2014 low. Since then, share value has surged almost 50%.
A steady decline, followed by a turnaround
Leading up to April's low, two key factors weighed on Baidu shares. The first was a general decline in Chinese Internet stocks. The big blow came when an SEC judge ruled in January that the Chinese units of the Big Four auditors would be prohibited from publishing accounting figures of U.S.-listed companies for six months.
The second factor was general concern about Baidu's loss of search market share. A few years back, Baidu could lay claim to 80% of China's search engine traffic. But upstart Qihoo 360 (NYSE:QIHU) came on the scene and within just two years captured 25% of the search pie, according to CNZZ. That meant Baidu's fell all the way to 58%.
But just when it seemed 2014 might be a year to forget, things quickly turned around for Baidu.
The rally kicked off when Baidu reported first quarter earnings in late April. Revenue growth accelerated and stood at 59%, while earnings blew past analyst expectations. Just as important, the company forecast that revenue would continue to grow by about 58% for the next quarter.
The most important part of that growth came from investments in mobile platforms. Those investments, management warned, would hold down earnings in the short term but provide a major boost in the long run. Even more important, the dominance of the company's mobile platform meant that it could capture more of the mobile search market.
That good news snowballed in July when the company reported second-quarter earnings. As expected, revenue grew almost 59%, but Baidu surprised with earnings that far surpassed expectations--bringing in $1.63 per share versus the expectation of $1.32. Continuing on the mobile theme, Baidu reported that 30% of total revenue came from that platform.
But perhaps most crucially, revenue per customer rose an astounding 50% between the second quarters of 2013 and 2014. That type of pricing power impressed investors and highlighted a major difference between Baidu and Qihoo -- as the latter is relying on cheaper ads to help attract revenue to its sites.
Of course, the most important question for today's investors is, what does Baidu's future look like?
The answer will likely have two parts. On the one hand, mobile will remain the crucial segment. As increasing numbers of Chinese consumers come online, they are likely doing so via a mobile device. Therefore, even though Qihoo has taken a sizable chunk of the search market, Baidu can regain a large swath by becoming the de-facto engine for mobile users.
The second theme will be the company's investment in infrastructure. Baidu is looking to expand its ecosystem to remain relevant for decades. Anyone familiar with Google (NASDAQ:GOOG)(NASDAQ:GOOGL) knows what this can look like: focusing on video, mobile payments, apps, and a plethora of other endeavors.
These investments will likely keep margins lower than they could be, but will be worth it if they can deliver important revenue boosters for Baidu.
Baidu now trades for about 32 times forward earnings. That's a hefty price tag. But this is also one of the highest-quality companies operating in China, and the growth potential is enormous. If you're interested in the company, it's probably worth initiating a starter position, then adding to it over time at better and better value points.
Brian Stoffel owns shares of Baidu, Google (A shares), and Google (C shares). The Motley Fool recommends Baidu, Google (A shares), and Google (C shares). The Motley Fool owns shares of Baidu, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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