Chinese growth stocks have been taking a beating lately, and the volatility is bound to continue in the near term. This has caused some pretty big markdowns on some former market darlings, and now we find Baidu (NASDAQ:BIDU) down 25% as of last week's close since peaking last November.
Is Baidu broken or is this the mother of all buying opportunities? Spoiler alert: I'm going to side with the bulls, but this doesn't mean that there aren't valid reasons to be skeptical.
Baidu isn't cheap by most conventional measuring sticks, even with the stock fetching a quarter less than it did eight months ago. The company behind China's leading Internet search engine is trading at a lofty 32 times trailing earnings, higher than the other regional top dogs.
However, Baidu's bottom-line performance is held back by investments in app marketplaces, online video, and group-buying sites that may not pay off right away. Patient investors with the luxury of time will realize that Baidu is actually trading at pretty reasonable profit multiples if we look out a couple of years. Baidu fetches 20 times next year's analyst target, 15 times the year after, and if we're willing to look out one more year to 2018, we find Baidu's P/E perched at less than 11 (according to S&P Capital IQ data).
Back out Baidu's bountiful wealth -- and we should since we're talking about nearly $9.4 billion in cash and equivalents for a company with a market cap of roughly $66 billion -- and Baidu's forward multiple drops to the high teens.
That's not too shabby, particularly for a company that's growing a lot faster than that. Revenue posted a 34% year-over-year surge to top $2 billion for the first quarter, and that's actually supposed to accelerate to between 36.5% and 39.7% growth when it reports second-quarter results on July 27.
Earnings growth hasn't been going along for the ride. That's where all of the investments that Baidu is making in low-margin niches is weighing on its financials. It also doesn't help that the migration from PCs to mobile devices has created monetization challenges, something that we have seen play out with declining online ad rates around most of the world.
None of this suggests that Baidu isn't a bargain at this point. Baidu's cheaper than the market thinks. However, things can still go wrong. China is going through more than just growing pains at the moment, and if the economy falters, this obviously tosses out the projections of heady growth in the coming years out the window. The media certainly seems to be playing things out that way. Let's go over some of the headlines being doled out over the weekend.
- "Is the sun setting on China's economy?" -- CNN
- "Signs of a Growing Hush in China's economy" -- New York Times
- "China market sell-off: Economic pain could spread across nation & world" -- The Economic Times
The headlines do seem pretty bleak, but they tend to break out whenever Chinese equity markets take a tumble. Yes, China's economy has been slowing lately. This isn't the well-oiled machine that was growing at a 10% clip a couple of years ago. However, most countries would love to be posting an annualized GDP growth rate of 7% that China is now generating.
The risks are real. That's part of the unspoken contract that investors make when they buy into Chinese growth stocks. Given Baidu's compelling valuation and enviable market position across more than just search these days, it's a sale worth taking advantage of now.