Baidu Stock Upgraded: What You Need to Know

By Rich Smith Markets Fool.com

2017 is the Year of the Roosterin China -- and analysts are crowing about Baidu (NASDAQ: BIDU).

Continue Reading Below

Last year, Baidu stock underperformed the market badly, losing more than 10% of its market capitalization as the S&P 500 gained 11%. But this morning, Hong Kong-based investment banker China Renaissance opened up the first trading day of the new year with an upgrade for Baidu, the Chinese internet giant.

Assigning a new price target of $204 on the $168 stock, China Renaissance argued that Baidu stock has "24% upside" for new investors. Accordingly, the analyst upgraded Baidu from hold to buy.

Here are three reasons why.


Image source: Getty Images.

1. Turnaround time for sales

Continue Reading Below

After growing strongly at a 40%-plus annualized rate over the previous five years, Baidu hit a bump in the road in 2016. Trailing-12-month revenue growth has been only 15%, and China Renaissance believes that Q4 results, when they come out, will show "trough"-level revenue, with full-year growth falling to just 6% -- but after that, things start to improve.

As explained in a write-up on StreetInsider.com, China Renaissance is forecasting 23% "topline growth" at Baidu this year. Most analystsare expecting Baidu will score $10.4 billion in sales when 2016 results are in, so, applied to that number, 23% revenue growth implies sales of $12.7 billion in 2017.

2. Profits should rise, too

Along with the rebound in revenue, China Renaissance sees profits turning around as well.

Baidu has been posting a bit more than 16% operating profit margins so far this year. China Renaissance sees this jumping up to 20% in 2017, however. If it's right, we should see not only 23% growth in revenues this year, but 23% growth in the profitability of each revenue dollar it collects.

3. Turbocharged growth

Put them together, and China Renaissance sees operating profits growing roughly 50% year over year in 2017. Data from S&P Global Market Intelligence show consensus forecasts sit at $1.5 billion for 2016 operating profits. Thus, China Renaissance appears to be forecasting operating profits of about $2.3 billion for 2017.

That's a bit ahead of consensus targets of $2.1 billion already -- but it gets better. According to China Renaissance, there's the potential for a further "10%+ upside in the bottom-line if [Baidu's] newsfeed product performs strongly." Last year, Baidu Chairman Robert Li predictedthat the company's RSS newsfeed product would attract a market of more than 70 million readers in 2017, giving the company a new place to sell ads and produce "meaningful" revenue.

If China Renaissance (and Baidu's chairman) are right, that could bump operating profits up to perhaps $2.5 billion.

The most important thing: Curb your enthusiasm

So what does all of this imply for investors? China Renaissance believes that Baidu stock, which sells for $168 today, will end this year at $204. That's a 24% gain from what the stock sold for before the upgrade -- with about 21% of those gains still available, after the stock jumped in response to the upgrade. These gains, however, are predicated on Baidu growing its operating earnings from $1.5 billion all the way to as much as $2.5 billion -- in just one year.

That's a pretty big leap, and it takes a pretty big leap of faith to think Baidu will get there. At $2.5 billion in operating profits, though, Baidu stock would be selling for about 23 times today's $57 billion market capitalization. At the $70 billion-ish market cap that China Renaissance is predicting one year from now, the stock's P/E would be closer to 28.

Both of these valuations seem reasonable, though, if Baidu does succeed in posting 50% growth in operating earnings this year. Moreover, both of these valuations are cheaper than the stock's current price-to-operating earnings ratio of 33.5. (The company's ordinary P/E, or price-to-net-earnings ratio, is currently distorted by $3.8 billion in one-time gains booked in Q4 of 2015).

Long story short: I agree with China Renaissance that Baidu stock could go up another 21%, if (and only if) the earnings growth materializes. But we'll have to wait almost two more months before we get confirmation from Baidu management itself that this growth scenario is likely. Tune back in on Feb. 23, when Baidu reports its full-year 2016 results, for an update on that.

10 stocks we like better than Baidu
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Baidu wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of Nov. 7, 2016

Rich Smith owns shares of Baidu. The Motley Fool owns shares of and recommends Baidu. The Motley Fool has a disclosure policy.