By Cameron Urdu
Normally I tend to stray away from investing in Chinese companies because I believe that there are enough well run American companies to invest my money in. However the one exception I have made to this rule in the past is a Chinese company called Baidu (BIDU). If you have never heard of Baidu, they own around 78% share of the online search market in China. Put simply, BIDU is to China, as Google (GOOG) is to the United States…eight years ago.
BIDU is a company with tremendous growth prospects going forward. According to Yahoo Finance, the estimated growth rate for BIDU over the next five years is 44.81% compared to Google at 18.15%. The picture below shows the earnings and revenue growth that BIDU has consistently generated since its IPO in 2005. Even during the economic slowdown in 2008 when the world economies were on the brink of collapse, BIDU was GROWING earnings and revenues.
Currently, BIDU trades at 31 times 2012 earnings estimates versus GOOG which trades at only 15 times 2012 estimates. This may lead you to believe that BIDU is grossly overvalued because if you assigned it a 15 times multiple like that of Google, you would get a stock price of $69.00, or more than 50% lower than the last closing price of $144.32. However as I discussed in my Fundamental Analysis post, one important aspect we need to take into consideration when determining what multiple to assign a stock is its growth rate.
If you factor in Baidu’s growth rate of 44.81%, you can then calculate that BIDU has a PEG (Price to Earnings Growth) ratio of 0.70 (31.24 multiple divided by 44.81% growth). Comparing this to Google’s PEG ratio of 0.84, you could make the argument that BIDU is actually CHEAPER than Google even though it currently trades at a higher multiple.
So how high do I think BIDU can go? Honestly I don’t know. Over the longer term, I wouldn’t be surprised to see BIDU’s market cap double from 50 billion to 100 billion as the growth in the online search in China continues to explode. Looking into next year, taking the average earnings estimate per Yahoo Finance of $6.47, and assigning a conservative multiple of 30 times to it, I get a $194 price target. While this would imply a 34% move higher from current levels, I believe this is a conservative estimate as the upside could be much greater if BIDU continues to beat earnings estimates as it has the past four quarters.
Looking at the daily chart of BIDU, you can see it has been basing for over a year now in the range of $104.00 and $167.00. In the left side of the base when BIDU started its correction, you can see wild and volatile trading that likely whipsawed a lot of traders. The big red volume bars on the left side of the base indicates that there were a lot of institutions (hedge funds, mutual funds, etc.) selling their stock. However on the ride side of the base, you can see textbook support coming into the name.
The clue here is that the stocks chart is tightening up, meaning the price swings are not as volatile which is a good indication that institutions are supporting the stock. Also note that BIDU has made higher lows and now appears to be in the process of making higher highs as volume is starting to come in. All these signs on the daily are BULLISH and make me think that BIDU is getting ready for a much larger move.
The weekly chart of BIDU also supports the bullish view of the daily chart. This is a stock that had a HUGE run up prior to last year and needed time to digest those gains. That kind of sideways movement in a stock, after such a huge move up is healthy and bodes well for future gains. One negative that I could point out is that while the broader stock market has already broken out and hit multi year highs, BIDU has not. This kind of weak relative strength compared to the broader market would normally be a caution sign, but in BIDU’s case, I believe this rest has been well deserved for a stock that has been up over 700% since the S&P 500 bottomed in March 2009.
Risks and Conclusion
No trade or investment is without its risks and one of the most important aspects of managing your own money is having a risk management strategy in place. When trading BIDU, one thing to keep in mind is that it is viewed by many as a proxy for China. This means if an investor wants exposure to China quickly, Baidu is a great stock for them to flood into because it is a legitimate company, with a large market cap (over 50 billion) that offers plenty of liquidity. The risk here is that a proxy stock like this can tend to be more volatile than your typical stock, meaning it swings in larger percentages and can stop people out of positions if you don’t give it a long enough leash.
However this can also be to your advantage if you are a shorter to intermediate term investor or trader. BIDU can ramp up 30% in a very short period and catching only a third of that kind of move can be very profitable.
Another risk associated with BIDU is that because it operates in China, you are dealing with a whole other animal when it comes to government regulations and censorship. Many don’t trust Chinese companies as a whole as many of the smaller companies have been found of fraudulently misrepresenting their accounting numbers. In 2011, China’s CCTV (China Central Television) accused BIDU of fraudulent advertising practices and phony search results. This is something to keep in mind when assessing your risk tolerance for investing or trading a stock like BIDU.
In conclusion, I like Baidu’s prospects on an intermediate term basis. I can see this stock going to over $200 if the stock market cooperates and this bull market run continues higher. Please trade this stock according to your own risk management style.
Full Disclosure: I currently do not own any shares of Baidu (BIDU), but this could change at any time in the next 24 hours.
About the Author - Cameron Urdu is the founder and editor of How to Buy Stocks, an online resource created to educate beginners looking to invest in the stock market. (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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