A Stock to Sell?

By Chad Henage - June 28, 2012 | Tickers: BIDU, GOOG | 0 Comments

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In a recent article by Sean Williams of The Motley Fool, he mentioned several stocks that he considered a sell based on his TMFULOI metric. He did take note that the company's score has been nearly cut in half in two months thanks to a recent strong quarter. His concerns about Baidu (NASDAQ: BIDU) were that China's growth is slowing, and that expenses keep rising in line with revenue. He did give a little bit, by saying that Baidu's valuation is getting more reasonable, but “it still is a far cry from a buy in my opinion.” However, I disagree with Sean's assessment.

Valuation on EPS:

The very first post I wrote on The Motley Fool Blog was about Baidu. At the time, I wrote that Baidu priced at $127.34 was undervalued based on the company's market opportunity and future growth rates. In January when I wrote the post, analysts were expecting future growth of 48.10% over the next five years. Today those same analysts expect future growth of 40.35%. So we can see that the company's future growth expectations have been cut by 16%. The company's forward P/E ratio back in January was 28.94, today that same ratio is at 27.86, a change of just under 4%. Some would say that looking at these numbers you can see why Baidu might be a stock to sell.

However, let's look out one more year and see if the stock still looks expensive. Analysts expect earnings for 2013 to come in 38.5% higher than 2012 and for the company to earn $6.33 per share. If Baidu just meets this expectation, at today's prices the stock sells for a 2013 P/E ratio of 18. How many companies can you name that are expected to grow earnings by 38-40% and in theory would sell for a P/E ratio of 18? I'll wait...yeah that's about how many I can think of too – zero. If Baidu meets earnings for 2012 and 2013, the company's PEG ratios for each year would be .62 and .45 respectively. By comparison, Google (NASDAQ: GOOG) has forward PEG ratios of .74 and .63 over the next two years. I understand that Google sells for a cheaper P/E ratio, but there is no question that Baidu's opportunity for growth in search dwarfs Google's. Why then does Baidu sell for a PEG of 16% less for 2012, and a 28.57% lower PEG for 2013?

Valuation on Cash Flow

While EPS and estimates are one thing, many people use cash flow as a better comparative tool when researching stocks. Look at the difference between Baidu and Google when we look at free cash flow on a few measures:

As you can see Sean is right that expenses have been growing faster than operating cash flow, however look at what's been happening at Google. Which would you rather have? Baidu has grown operating cash flow at a rate much faster than Google. Baidu also generates more free cash flow per $1 of sales and $1 of assets than Google. Keep in mind this is a company that is seen as more expensive than Google. If you really dig into the cash flow numbers it looks like Baidu is cheaper than Google on these important metrics.

Conclusion

You can see that if you take the time to look past just the 2012 estimates for Baidu, this stock is not really that expensive after all. What I see is a company posting huge growth, generating significantly more free cash flow than their most well respected competitor. I don't see that as criteria for a stock to sell. Sorry Sean, you and I are going to have to agree to disagree on this one.

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