Avoid Yahoo, Buy This Hot Chinese Stock Instead

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

If you are looking to invest in search companies based on the mobile growth curve ahead, I encourage you to look at US as well as Chinese producers. In the latter market, the competition is more intense but upside is also stronger from rising consumer wealth. I recommend avoiding established stocks that are seeing mostly either share erosion or slow developments in mobile. Below, I review Baidu and Yahoo with these thoughts in mind.

Is Baidu (NASDAQ: BIDU) "The Google of China?"

While Baidu is China's largest search business with 73% of the market, it is by no means comparable to Google for several reasons. First, for this company, mobile is not a tailwind like it is for Google--it's a headwind. UCWeb, which earlier in mid-2012 was viewed as a takeover target by the emerging market search company, eclipsed 100 million Androids in November. They are by far China's leading smartphone platform and will make it even more difficult for Baidu to monetize mobile. Baidu's mobile search share is a fraction of PC search share. According to Oppenheimer, in mid-2012 Baidu's mobile search share was 34% versus 80% in PC search. In October, search business came out to 73%. As mobile smartphones increasingly take over Internet traffic search from PCs, Baidu is thus in a world of pain unless it acts fast.

To its credit, Baidu has taken the appropriate step of partnering with China's #2 smartphone vendor Lenovo to sell LePhone A586, which runs on a Baidu Android-based operating system and contains Baidu's cloud services. However, even the core business is struggling. Qihoo (NYSE: QIHU) came out of virtually nowhere after emerging in August to gain 10% of the Chinese search market. It is now pushing for a 15-20% share of the Chinese search market and has hired ex-Google employees for help. The firm is also taking advantaged of its newfound popularity to introduce a music search engine, which aims to upset Baidu's lead in this market as well. If it achieves anywhere close to the kind of the success that it did in search, Baidu may struggle to win over smartphone users that are more accessible in the music business compared to their PC counterparts.

Baidu trades at 16.1x forward earnings versus 24.9x forward earnings for Qihoo. However, the latter clearly merits this premium, because it is forecasted for 1,000 bps greater average annual EPS growth. I encourage backing Qihoo over Baidu, since it has those positive catalysts in plank.

Avoid Yahoo (NASDAQ: YHOO)

In my view, Yahoo has been on an unreasonably strong bull run. Since August, its stock has shot up like a rocket to reach a 52-week high that is around 37% above the lows. This is particularly unwarranted, since most of the changes that have been made to the poor performing search company have been related to corporate governance. For example, it recently added ex-PayPal and Intuit employees to the board in a move that essentially added a fourth representative of activist hedge fund Third Point.

What makes me disinterested in an investment in Yahoo is that it essentially shares much of Baidu's downside story in regard to mobile. The company is so far behind in mobile (When was the last time you saw its search engine used on a high-end device?) that I am afraid the expected growth curve ahead is much too optimistic. The company has rolled out mail apps for Android, Windows 8, and iOS, but comScore actually estimates that Yahoo Mail registered a 16% y-o-y decline in November domestic unique visitors.

Analysts expect Yahoo to grow EPS by a rate of 11.7% over the next five years (again much too rosy, in my view). Assuming expectations are met, 2016 EPS will come out to $1.60. At a multiple of 15x, this translates to a future stock value of $24, which provides for an average annual return of 4.8%. It simply would take either too much growth or too much multiples expansion to justify actively investing in the company. For this reason, I recommend going along with the consensus, which is to avoid the stock.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Baidu. Motley Fool newsletter services recommend Baidu. 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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