Will Yahoo Continue to Soar? Consider This 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.

Investors familiar with the US search engine market think instantly of Google (NASDAQ: GOOG). With a domestic all-time high search share of 70%, the company has the market sealed. While launching a superior results algorithm to Google may be the dream of every starry-eyed Computer Science major, brand is critical in the current search landscape--just ask Yahoo, which has struggled to turn around its own business. However, the Chinese search market is substantially more dynamic, with more market movement and consumer trends. See below for a review of US and Chinese players in search.

A Look at the Chinese Search Market

Baidu (NASDAQ: BIDU) is China’s equivalent of Google, a local search company offering web services. Recently Qihoo (NYSE: QIHU), China’s top anti-virus company, took 10% share of the Chinese search engine market, where they operated just a few months after their August launch. They also said they’ll add an ad service in the year of 2013. With such success, Qihoo is now aggressively trying to get another 5-10% share and has hired ex-Google employees.

The Chinese search market is very competitive, but Baidu has retained the leadership despite threatening competition. Sohu, for example, can leverage its music search business, the 2nd largest in the emerging market. And Qihoo’s recently launched music search engine threatens both Sohu and Baidu. But the size of the pie has gotten bigger and bigger with the number of Chinese Internet users rising 10% y-o-y to 538 million. This growth is being furthered by the proliferation of smartphones--270 million were activated with subscriptions in December 2012.

Baidu is now also targeting the smartphone industry, but UCWeb represents a major obstacle. The latter reached over 100 million Android users in November, making Baidu’s goals much more difficult. The only advantage Baidu currently has is that it offers multiple search engines. Search share is mostly divided by the PC and mobile markets, and PC currently holds a much higher amount than mobile. Baidu’s share was 34% before, until coming to a high of 80% in the middle of 2012. In October, the business ended with 73%. The company also partnered with China’s No. 2 smartphone supplier, Lenovo, to sell the LePhone A586, which uses Baidu’s Android-based operating system and has its cloud services integrated in it. So, there's strong momentum.

But the question is whether this momentum (and, again, there are several headwinds) has already been factored into the stock price. At a respective 22.9x and 17.1x past and forward earnings, I wouldn't call the company a "sure bet." If the forward multiple contracts 8% to Google's level, growth will still likely enable the company to outperform. The balance sheet is clean and EPS has gone up by the high double-digits in the recent past. When you factor in the 33.6% price decline from the 52-week high, you may even begin to conclude that investors are betting on the market buying in from a low.

Why You Should Avoid Yahoo (NASDAQ: YHOO)

Yahoo is slowly falling behind in the search engine race, although their stock returns in recent months would suggest otherwise. They have conducted a lot of changes in corporate governance, with announcements that the company will hire ex-PayPal and Intuit workers to the board. Dan Loeb, an activist hedge fund manager of Third Point, influenced the adding of PayPal employees. Shares have risen a meteoric 35.2% from the 52-week low, largely as a result of his efforts to reform the company.

Currently, Yahoo is also falling behind in mobile. They released mail applications for Android, Windows 8, and iOS; but that’s about it in their attempt to enter the market. Unique domestic Yahoo mail registrants have declined by 16% y-o-y in November, according to comScore’s estimates. They also entered in a deal with NBC Sports for Yahoo to gain access to live streams for ad-space sales purposes, as Yahoo Sports is one of few areas where the company is still strong.

At 16.9x forward earnings, the reaction to Loeb's efforts appears to be a bit overdone. Google, which has been on a sharper growth trajectory, trades at only 15.9x forward earnings. Moreover, Google also has a stronger balance sheet with a quick ratio of 3.9x. It is forecasted for 15.5% annual EPS growth over the next five years, which I believe is pessimistic if anything. During the past five years, it grew much faster and had less resources to leverage in its expansion. From new YouTube advertising to Android monetization and the inevitable release of "X Phone," Google has plenty of catalysts that weren't there five years ago (to say nothing about Google X, which includes pie-in-the-sky projects like driverless cars and virtual glasses). For this reason, I strongly recommend investing in Google over Yahoo to capitalize off of both a market correction and continued superior appreciation of the former.

TakeoverAnalyst has no position in any stocks mentioned. The Motley Fool recommends Baidu and Google. The Motley Fool owns shares of 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. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a position in the next 48 hours.

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