Baidu Looking Good for the Long Term

NEW YORK (TheStreet) -- Surprise volatility is a common characteristic in Chinese stocks.

But there are still companies with stable fundamentals and positive outlooks that can be found trading at bargain prices. One example can be seen in Baidu ( BIDU), the company typically referred to as the "Chinese Google."

Baidu commands an impressive 70% market share in China's online ads and search spending. The stock has been beaten up in recent months and shows year-to-date losses of nearly 10%. This creates a scenario where valuations are relatively cheap at a time when growth rates are poised to make large runs higher.

The broader scenario in China looks bleak at the moment.

The country's credit bubble bears some alarming similarities to the U.S. credit crisis in 2008. This has pushed down Chinese stock values by nearly 15% so far this year, a stark contrast with the bull run in global markets during the same period.

From a value perspective, however, this has left some quality companies wallowing in oversold territory. For investors with long- term time, some attractive opportunities can be found -- and one of the stronger cases can be made for Baidu.

Its revenue are expected to rise by 35% in 2013, based largely on continued growth in the number of Chinese internet users. Lower-tier advertisers recognize these trends and continue to direct more advertising money toward online venues.

Earnings per share for 2013 are expected to hold below $5, however, and this weaker increase (a mere 4%) is being attributed to rising costs and stalling sales.

Looking at stock values, the latest run lower has shaken-out many of the most bullish investors, and damaged sentiment for the stock's prospects. The highs from 2011 topped-out at nearly $160, and Baidu now trades below $90 (or 18 times earnings).

Still, this compares favorably to some of the sector's main players, as Google's ( GOOG) valuation is now seen at 26.4 times earninGs

. And when we look at projected earnings per share, Baidu's valuations start to look excessively cheap.

Strengthening forecasts for Baidu are based largely on the fact that China's internet penetration remains low, near 40%, which is roughly half of what is seen in South Korea, Japan and the U.S.

China's plans to boost high-speed internet connectivity will begin to balance-out these numbers and create a supportive framework for online advertising.

The vast majority of Baidu's revenue (upwards of 90%) comes from paid search, but new investment in ad exchange services will allow the company to sell its offerings on external sites.

Strategies like these generate roughly one-third of Google's advertising revenue, and once Baidu starts to gain traction in these areas, profit performance will grow as well.

Overall, this paints a bullish picture for Baidu.

It should be noted that lower profit margins are generated by third-party ad programs, when compared to paid search (as they are diminished by revenue sharing). But once we start to see upswings in Chinese stocks, Baidu is positioned to be one of the top performers.

As a comparative example, Google has been a market leader since stocks hit their lows in 2009, rising nearly 350% in the process. Given its relative position in the market, strong upside in ad spending and margins should be seen for Baidu once China's economy shows signs of stabilizing.

This means the stock is a "buy" at current levels.

Google's limited exposure in the Chinese market opens the door for companies like Baidu to continue to benefit from the changing demographics and growing internet penetration expected in the next five years.

Baidu's services are comprehensive and varied, offering everything from message boards to maps, games and video. Perhaps its greatest potential is in mobile search, which is still largely underutilized and offers massive opportunities for growth.  Given these factors, Baidu stock is trading well below its fair value, which creates excellent opportunities for long-term investors able to absorb the higher volatility that is associated with Chinese stocks.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is a university teacher in international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of websites, including MarketBulls.net, Seeking Alpha, FX Street, and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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