Better Buy: Baidu Inc vs. Google

By Adam Levy Markets Fool.com


Image source: Google.

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Google is the dominant online search engine nearly everywhere in the world except China. China just so happens to be the largest internet population in the world, but censorship laws in the country prevent the Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) company from operating how it would like to there. In its absence, Baidu (NASDAQ: BIDU) has built a commanding position, modeling itself off of the global leader in search.

Investors may look to Baidu for the significant growth opportunities that still lie ahead for it as China transitions from 3G mobile internet speeds to 4G and more consumers come online. But the steady growth of Google and its larger global presence may present a better buy right now.

Let's take a look at how they compare.

Revenue growth

Baidu is a much smaller company than Alphabet with a market capitalization of $57 billion compared to $555 billion. And it was growing revenue relatively quickly as it rapidly brought on more advertising customers and its active user count increased.

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However, over the last year, revenue growth slowed to a crawl as it has gone back and validated all of its advertisers, weeding out some bad apples. Last quarter, Baidu's total revenue declined 0.7% year over year. If you exclude the impact of Qunar, the online travel search engine it sold its stake in earlier this year, revenue grew a modest 6.7% year over year last quarter. Over the trailing 12 months, Baidu's revenue grew just 3%.

Baidu does expect revenue growth to return next year as it finishes validating its advertisers. Still, the company has experienced slowing revenue growth for several years now.

By comparison, Alphabet's revenue grew 14% over the last year. In fact, the company's revenue growth is accelerating. During the third quarter, Alphabet reported 23% revenue growth on a constant currency basis, up from 21% growth the year before.Most importantly, Alphabet's revenue growth has remained relatively steady over the last several years even as it's become one of the largest revenue generators in the world.

Earnings growth

Google's parent company is also better at turning its revenue into profits. Alphabet's profit margin through the first nine months of 2016 was 22%. Baidu posted a profit margin of just 14%.

Again, Baidu has the potential to improve margins if and when its current investments in its varied market opportunities pay off. Sales, marketing, general, and administrativeexpenses amounted to 32% of Baidu's revenue in the third quarter. Alphabet, by comparison, spent just 20% of revenue on SG&A expenses last quarter.

Analysts currently expect Baidu to grow earnings per share 33% next year. That's slightly better than expectations for Alphabet, which is anticipated to grow 19%. But where analysts expect Alphabet to continue growing at a fairly steady 19% clip over the next five years, they see Baidu's earnings declining an average of 2% per year over the next five years.

Valuation

Despite the poor long-term outlook for Baidu, investors are still giving it a premium price. Shares currently trade for 29 times next year's earnings expectations. By comparison, Alphabet shares trade for just 19 times next year's earnings expectations.

Baidu's sales are slightly discounted to Alphabet's with a price-to-sales ratio of 4.7, compared to 5.3 for Alphabet. But with Baidu's slowing sales growth, the discount ought to be much bigger.

The relatively cheap valuation of Alphabet combined with its steady revenue growth and higher profit margin make it a better buy right now than Baidu. Baidu has a lot of potential, but as it transitions out its advertiser validation, it needs to prove it can attract more legitimate advertisers to its platform and grow their average spend. Alphabet just needs to keep doing what it's doing.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and 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.