Three Investing Lessons From Baidu

AnnaLisa is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Baidu (NASDAQ: BIDU) investors have been learning some hard lessons of late. Often called the Google of China, since its peak around $165 (split adjusted) in the summer of 2011 the stock just hit a 52 week low intraday on December 4 of $89 and change. The latest hit to the stock was due to news that the SEC is going forward with enforcement of its reporting requirements for foreign entities trading publicly in the US. Other Chinese internet stocks were hit with this news and were down over 5% as well.

Once Baidu was one of the most high flying of stocks and investors made huge returns, but if they didn’t take profits they’ve round tripped to breaking even or worse a loss. What are the three lessons that Baidu investors have learned besides humility?

Lesson One

Trading in foreign entities carries more risk. When Google (NASDAQ: GOOG) withdrew from China due to government censorship it left Baidu a clear winner in the huge market that is China. According to the most recent update to its 2012 Internet Trends outlook , Kleiner Perkins Caufield Byers analyst Mary Meeker ranked China as number one in global internet usage with only 40% market penetration with 538 million users and year over year growth of 10%. But the constant specter of government intervention looms over Baidu and its internet ilk. So far, Baidu has an amicable relationship with the government, but has had to tread very carefully to maintain it.

In this most recent share price dive the problem lies with what the Chinese government allows to be divulged and what the SEC requires. The international difference of opinion will likely have to be resolved at a diplomatic level and delisting of other Chinese stocks is by no means an impossibility.

These clashes of international economic culture have hit other companies when they run up against barriers to trade like the Foreign Corrupt Practices Act affecting large cap companies as Wal-Mart, Las Vegas Sands and Wynn Resorts. With the cost of doing business including the gifting of foreign officials seen as bribery, American companies have problems working in countries whose infrastructure is rife with graft. Baidu was caught up in a scandal just in August 2011 when China Central TV revealed, in an undercover investigation, how advertisers paid Baidu extra to be bumped up on search ranks.

Then, investing in a foreign entity makes it more difficult to keep up with due diligence, even despite the language barriers. In addition, Chinese stocks have convoluted collaborations and mergers and conflicting interests (for my sherpa guide to Chinese internets click here.)

Finally, with the stringent requirements for listing a stock in the US some companies in China are losing interest and are taking help from the China Development Bank to buy their way off American exchanges.

Lesson Two

Just because a company has a near monopoly doesn’t mean it will always have a moat. Baidu has seen selling pressure as Qihoo 360 Technology Co. Ltd (NYSE: QIHU), a smaller upstart with a $3.07 billion market cap, has been gaining traction in the Chinese mobile space. Although latest numbers from Qihoo indicate it hasn’t yet taken significant market share from Baidu and according to an Investors Business Daily article it has actually taken more share from Google, the company has multi-year plans to challenge Baidu on gaming and mobile search. Aside from the drop in share price due to the SEC news, Qihoo had been trading near 52 week highs and after the SEC drop is still trading at a 3.88 P/E.  Qihoo also has a strong internet and mobile security offering, ever more necessary in the People’s Republic.

Baidu, at ten times the market cap of Qihoo, trades at a much higher multiple at 20.39 but with a forward P/E of 14.87. It still has an impressive return on equity of 50.39% with an enviable profit margin of 47.1% and over $2 billion in cash.

While Google has YouTube and android and tablets, Baidu is still working on the latter two and the Chinese equivalent of Youtube is already represented by two other Chinese internet stocks. Just today on the Google home page there is a plea for world governments to open up the internet. Could that be a signal that Google hopes to return to China? That would certainly be a game changer for Baidu's domination of the Chinese market.

Lesson Three  

Momentum names can lose their mojo. Baidu was one of the hottest names for the last five years but the law of large numbers has come into play with a deceleration of their sizzling growth. Analysts and fickle traders move out until a stock's P/E becomes a value proposition. Without any yield Baidu is still not at that point. Their growth rate is double digit still, but expectations had run so high that Baidu was unlikely to meet them. The percentage of growth expectations by analysts for Baidu has dwindled from 88% per annum for the last five years to 38% going forward.

Analysts' enthusiasm for the name has waned with only 8 strong buys now from 13 three months ago. The mean price target is now $141.32 which leads to considerable upside from here. That's cold comfort for those who bought higher only a few months ago.

For most companies, Baidu's numbers and growth prospects are only pipedreams. Now, that it has become a more fairly valued proposition it may be time to test the waters. That said any bad news on the Chinese economy will hit the stock, regardless of Baidu's fundamentals.

Pop Quiz

Our question for the day is whether, lessons learned, it's time to buy Baidu. Like Apple, Google, and other tech titans, Baidu is a leader in its market with plenty of market left. Risks are clearly defined now including that niggling matter of the Chinese government.

Baidu's not going to be the easy money it once was and gains will be hard won but the two trends it embodies, growth in China and internet and mobile adoption can't be denied.

leglamp has no positions in the stocks mentioned above. The Motley Fool owns shares of Baidu and Google. Motley Fool newsletter services recommend Baidu and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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