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Baidu Begins the Long Road Back

By Rick Munarriz - Sep 17, 2015 at 11:00AM

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China's leading search engine moves higher for a change.

Source: Baidu. 

Yesterday was a good day to be a Baidu (BIDU 2.13%) shareholder. The stock moved 6.3% higher on Wednesday, and while that may not seem like much of a move for a stock that has been one of the market's biggest winners over the past decade, it's a huge pop for a stock that has had a lousy 2015. 

It's actually Baidu's second-biggest single-day gain this year, and not too far from the stock's best trading day of 2015 when it merely rose 6.8%. We're holding out for the stock's first double-digit percentage pop of the year.

Yes, it's been a bad year. The stock is trading 34% lower year-to-date, but the silver lining is that Baidu's stock hit its highest close in nearly three weeks. Bearish sentiment may have bottomed out during last month's flash crash, and now it's time for China's leading search engine to prove that it's a market darling again.

Baidu won't be able to literally earn that right. Wall Street sees a sharp drop in profitability through the next couple of quarters. Revenue growth will be there. Analysts see year-over-year top-line growth continuing to clock in north of 30% for the next several quarters. However, Baidu's investment in online-to-offline -- or O2O -- initiatives will continue to weigh down its bottom-line results.

As bad as it may seem to see Baidu's stock shed more than a third of its value this year, Wall Street profit targets have actually taken an even bigger hit. In other words, shares of Baidu are actually more expensive now on a forward earnings basis than they were when the year began. 

That's going to test the resolve of growth investors. Baidu has been a market darling since going public at a split-adjusted price of $2.70 in 2004, a 55 bagger in its 11-year trading history. It became a rock star with stateside investors on a heavy diet of growth on both ends of the income statement and blasting through Wall Street's profit targets.

That's not the case these days. Net margins have contracted every year since peaking at 46.9% in 2012, according to S&P Capital IQ data. Baidu has also missed analysts income forecasts in two of the past three quarters. The challenges of mobile monetization -- something that has happened to most dot-com giants no matter where they hail from -- and pushing into low margin O2O businesses have suppressed near-term earnings growth. 

The push to make near-term investments with long-term payoffs isn't necessarily a bad move, as long as Baidu is able to educate the investing public on its intentions. If we go by the recent stock upticks after a period in which Chinese stocks in general took a beating on slowing economy concerns, it may be starting to get it right.

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