Baidu (BIDU -0.93%) will report its financial results for the second quarter after the market close on Monday, July 27. Investors will be scouring the Chinese Internet search giant's earnings report for evidence of success in the following three key areas.
Make no mistake: An investment in Baidu is an investment in growth. Investors have been somewhat willing to overlook profit growth that's lagged revenue growth in recent quarters, under the premise that Baidu's investments outside of its core search business will eventually pay dividends. Should Baidu's top-line numbers disappoint, however, it's unlikely that investor will be so forgiving.
In its first-quarter press release, Baidu issued revenue guidance for the second quarter in the range of $2.640 billion to $2.702 billion, which would be a 36.5% to 39.7% year-over-year increase. Analysts expect Baidu's revenue to come in near the midpoint of that range at $2.67 billion, representing 38.2% growth, as per Yahoo! Finance. Revenue figures that come in at or above $2.7 billion will likely be met with applause; numbers below the figure could be met with selling.
Fools, however, strive to not overreact to short-term events. I like to incorporate quarterly results into my long-term perspective of the businesses in which I invest. But these results only help to inform my view; rarely do they ever drive investment decisions in and of themselves as they represent only a small collection of data points to a far larger story.
I find it more beneficial to focus on the big-picture drivers of business success. For Baidu, they include its dominant competitive position and massive long-term growth opportunity. Baidu accounts for more than 80% of China's Internet searches and 40% of the country's mobile app downloads. With a virtuous cycle of data collection similar to Google that helps to strengthen and defend its core search business, it will be extremely difficult for competitors to displace Baidu from its leadership position. And with less than 50% of China's 1.4 billion people connected to the Internet today, Baidu still has many years of growth ahead.
Yet in order for Baidu to fully capitalize on the growth of the Chinese Internet economy, it must make further progress in its mobile initiatives. That's because a major shift is under way, with a relentless, global movement toward mobile computing.
Many investors feared (and some likely still do) that Baidu would be harmed by this shift. Yet it has invested heavily to transform the company from a primarily desktop-based business to a mobile leader. It acquired 91 Wireless, a leading mobile-apps marketplace, and expanded into mobile maps, streaming video, and a plethora of other mobile-based services.
Those investments are beginning to bear fruit, with mobile revenue accounting for 50% of total revenue in the first quarter of 2015. Investors will be looking for continued mobile momentum from Baidu in the second quarter.
The shift toward mobile and away from desktop-based computing also helps to explain why Baidu's revenue has grown faster than its profitability in recent quarters.
Mobile search typically generates lower cost-per-click rates than desktop search. CPC is the price advertisers pay each time someone clicks on their ad, which can also be viewed as Baidu's revenue per click.
Lower mobile CPC, along with the heavy investments in mobile-focused services that Baidu has made -- and continues to make -- in order to meet that challenge, has taken a toll on Baidu's profit margins. Net margins declined from 46.9% in 2012 to 32.9% in 2013 to 26.9% last year.
Accelerating revenue growth has softened the blow, with sales surging 53.6% in 2014 after rising 43.2% in 2013. Yet it's unlikely that investors will remain patient if margins continue to decline. Should it become clear that Baidu's margin deterioration is a long-term trend, investors will likely revalue Baidu's shares lower. Fortunately, Wall Street appears to expect margin stabilization to occur next year, with consensus estimates for roughly 33% growth in both revenue and earnings in 2016. Should Baidu demonstrate progress in this regard sooner than Wall Street expects, its investors could be well rewarded.