Better Buy: Baidu Inc. (ADR) vs. Alphabet Inc.

By Markets Fool.com

Image source: Getty Images.

Continue Reading Below

When the internet was in its infancy, analysts scoffed at the idea of an online company being able to earn significant sums selling advertising space. But over the past fifteen years, the shift to digital ads has been significant -- and there's still a long runway for growth.

That helps explain why two of the world's leading search engines -- Alphabet's(NASDAQ: GOOG)(NASDAQ: GOOGL)Google and Baidu (NASDAQ: BIDU) -- were able to rake in tens of billions of dollars over the past year alone. But which is the better stock to buy now?

That's a tough question to answer -- especially for me. The two companies combined account for 24% of my real-life holdings. And while there's no foolproof way to determine which is the better buy, there are three critical lenses through which to view the question.

Financial fortitude

Even though it might not be exciting, cash is the ultimate weapon. If the economy goes south, a company with lots of cash on hand has options: It can outspend rivals, buy back its own stock, or even acquire competitors at depressed valuations.

Continue Reading Below

Companies which have debt are in the exact opposite position: Their options are limited. They are forced to reduce investing in their future, to focus solely on squeaking by and meeting their debt obligations. That's why a company's financial fortitude is so important.

Company

Cash

Debt

Net Income

Free Cash Flow

Alphabet

$77 billion

$6 billion

$17 billion

$18 billion

Baidu

$17 billion

$1 billion

$4.9 billion

$2.3 billion

Data sources: Yahoo! Finance, SEC filings. Net income and free cash flow are on trailing twelve-month basis. Most figures rounded to nearest billion.

It's important to note that Alphabetis currently valued (via its C shares' market capitalization) at over nine times that of Baidu. Taking that into consideration, Baidu actually appears to have the slightly stronger balance sheet.

But what we're really measuring here is the level of cash versus debt, and each company's ability to create more cash flow. As far as these variables are concerned, both companies are in outstanding shape.

Winner: Tie

Sustainable competitive advantages

There's nothing more important to your investment's success than the underlying company's sustainable competitive advantages -- also known as a "moat." The moat provides both safety and the magic of compounding over years and decades.

Both Google and Baidu have strong moats. Google has seven different products with over one billion users. It is by far the largest search engine in the world, and it has the most data on users to offer advertisers.

Baidu's moat exists largely because Google refuses to actively compete in China, due to the policies of the ruling Communist party. But the same thing that protects Baidu -- a favorable competitive position thanks to the government -- is its greatest weakness. Should the company fall out of favor with Chinese leaders, the company and its stock could suffer immensely.

Google, operating in just about every other country worldwide, has no such risk. It would take virtually all governments cracking down on Google's data collection for the company to be hurt as directly as Baidu would be in the case of government intervention.

Don't get me wrong: Both companies have strong moats. But Google's is wider.

Winner: Alphabet

Valuation

Finally, we need to determine how expensive each stock is:

Company

P/E

P/FCF

P/S

PEG

Alphabet

24

30

6.7

1.3

Baidu

40

25

5.4

2.0

Data sources: Yahoo! Finance, E*Trade, SEC filings. Header ratios: price to earnings, price to free cash flow, price to sales, price/earnings to growth.

The data offers a mixed bag. Baidu has been investing heavily in its online-to-offline (O2O) initiative -- which is making the company's P/E look much higher than it would if the company just let revenue drop to the bottom line. But O2O is a massive opportunity -- one that I'm sure Alphabet would love to capitalize onif it could go back in time to the infancy of the internet.

At the same time, Alphabet is 35% cheaper when considering its growth potential (via the PEG ratio). Both companies have a bright future -- one that includes lots of small experiments that could end up being big hits. Those are difficult to predict. As a result, I think it's most fair to call this one a draw.

Winner: Tie

So there you have it: Two of the world's most dominant search engines are pretty close, but Google has a slight edge. But I think both deserve consideration in your own portfolio:They are stalwarts at the leading edge of the world's massive transition to online advertising.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Brian Stoffel owns shares of Alphabet (A shares), Alphabet (C shares), and Baidu. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and 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.