Don’t Buy Baidu. Here’s why Google is a Better Bet

When the pundits are all singing the same song, I say it’s time to move on.
Right now they are all taking pot shots at Google (GOOG). CNBC’s Jim Cramer slams Google because of the company’s decision to put China on the back burner. The experts on television and the Internet warn that Goggle has followed Microsoft (MSFT) into middle age, and faces a dull future.
Hogwash.
Those who are down on Google now say that China’s leading search engine, Baidu (BIDU) is a better bet. I say it’s a risky bet.
I’ve got nothing against Baidu. In fact it was one of my best calls was when I recommended a buy of Baidu shares one year ago. Back then, the stock was trading at a level of more than $350 a share. After a ten-for-one split, Baidu is now selling at more than $73 per share. That’s a gain of more than 100%.
Baidu cheerleaders boast that the company is expanding in the world’s fastest growing Internet market. True enough. A new report says the number of Internet users in China has soared past the 420 million mark! That’s a huge number, and it is growing. But, that does not mean investors should sell Google and buy Baidu at any price.
The Contrarian View
Google investors took a big hit last week when the company issued its Q2 earnings report. Shares prices plummeted by $34.41, shedding almost seven percent of their value in Friday’s trading.
It has been a rough year for Google. Shares have lost more than 25 percent of their value. That’s worse than the NASDAQ and even worse than Microsoft’s performance. But Baidu has performed like a champion by comparison.
Now, one of my competitors is advising clients to back up the truck and buy more Baidu. Here’s his pitch: “Last quarter, BIDU posted a whopping 165% surge in net income. Sales also rose by an incredible 60%, blowing past analysts’ expectations and resulting in a 33% earnings surprise. The stock jumped 14% on that news and a repeat this quarter should do the same.” So he says.
But not so fast! Baidu’s chart suggests that the days of endless share price gains may have ended. Over the past quarter, prices found a peak above $80 and became range-bound at best. Technical indicators suggest an ongoing easing of Baidu’s peak prices.
What about the chance of another earnings surprise? Baidu’s P/E multiple of 96.75 suggests that huge earnings increases are already built in to the stock’s valuation. A forward P/E valuation of 37.32 also suggests great future expectations are already priced in.
When a stock is this highly valued, anything short of a revenue jackpot could obviously result in a severe drop.
Take a look at Google’s recent plunge. Before its earnings announcement Google shares sported a relatively modest 22.39 P/E multiple.
And what was the shocking news that caused Google to lose almost seven percent of its value? Profits increased! Google posted a profit of $1.84 billion, up from $1.49 billion a year ago. Revenue jumped to $6.82 billion from $5.52 billion.
More than a billion dollars in new revenue weren’t enough to support Google’s modest valuation. A one percent increase in operating costs, and a miss of few cents on earnings per share, spooked the market.
To say the least, markets are extremely nervous.
What the Cheerleaders Don’t Tell You
Starry-eyed Baidu boosters are not telling you how thin the ice is. Sure, income may be up by 165%. But Baidu’s total income barely made it above $70.4 million in the last quarter.
China’s Internet population may be huge, but Baidu’s profit of $70.4 million isn’t even in Google’s billion-dollar league.
Critics like Jim Cramer claim that Google is missing out on hundreds of million of dollars worth of profits in China. But Google had only 30 percent of the Chinese market and it has not exited China entirely. What’s more, Baidu’s profits suggest that the prize is simply not yet all that large yet.
How is that possible? My research into Chinese Internet marketing suggests there are two key problems. The Chinese people are not yet accustomed to buying and advertising goods online. That’s one reason that Baidu’s Internet sales were only $189.6 million in their latest quarterly report. Compare that to Google annual revenues of $6.82 billion. Marketing experts say that Baidu has not mastered advertising on the web nearly as well as Google has.
The best way to compare the real valuation of the two firms is to look at the price-to-earnings-growth ratio (PEG). The PEG ratio shows investors are now paying almost twice as much for Baidu’s earnings growth as they are for Google’s.
Baidu’s PEG is a very high 2.02. Google’s PEG is a surprising 1.03!
Those who compare Google to tech dinosaurs like Microsoft are ignoring the differences. Every computer user knows very well that the Microsoft is struggling to produce new operating systems and software that anyone wants.
Meanwhile Google’s new products are being snapped up around the world. The Android OS for cell phones is quickly catching up with the iPhone in global popularity and is supported by many more telecom companies. Google’s other products are constantly being upgraded. The firm’s increased operating expenses in the last quarter were related to the purchase of valuable advertising companies like AdMob.
Google didn’t become a “mature” company or a tech dinosaur when its earnings crossed the billion dollar mark. It is still one of America’s technology leaders and is still growing earnings aggressively.
Right now I believe that Google is dirt cheap compared to Baidu.
Forget about investing with your eye on the rearview mirror. Baidu’s past performance is impressive. But now it is priced for huge success, or for huge disappointment if it misses expectations by even a fraction.
Baidu carries frightening risk at today’s valuation. But Google has been beaten down to a point where the chances of investor rewards with this tech leader are obviously greater and the risks are smaller.
I’m ignoring the talking heads. I’m selling Baidu and buying Google.