Baidu’s Stock Is Getting Too Cheap to Ignore

MarketsMotley Fool

Shares of Baidu (NASDAQ: BIDU) recently hit fresh 52-week lows amid ongoing concerns about the trade war hurting the Chinese economy. However, I believe that investors are too bearish on Baidu and the stock could easily rebound for a few simple reasons.

Limited exposure to the trade war

Continue Reading Below

The escalating trade war between the U.S. and China mainly focuses on imported and exported commodities and consumer products. Baidu generates most of its revenue by selling display ads in China.

The trade war might affect Baidu and other online advertisers if Chinese companies cut their marketing budgets to offset slower sales -- but that's a worst-case scenario. Instead, advertisers probably will ramp up their spending on online ads to gain more customers in a tighter and more competitive environment.

A strong core business

Baidu's online marketing revenues rose 25% annually, to 21.1 billion RMB ($3.18 billion) last quarter and accounted for 81% of its top line, and its active online marketing customers grew 9%, to 511,000. Both figures accelerated from the previous quarter when Baidu's marketing revenue and active customer count rose 23% and 5%, respectively.

Baidu's average revenue per online marketing customer also rose 16% annually, to 41,200 RMB ($6,200), as its traffic acquisition costs (TAC) increased just 9%, to 2.7 billion RMB ($408 million). Its TAC as a percentage of total revenues fell from 12% a year earlier to just 10% -- indicating that the company isn't spending too much money to gain customers.

A lack of serious competitors

Baidu's TAC is low because it has pricing power as the 800-pound gorilla in China's online advertising market. The company controls 66% of China's online search market, according to StatCounter. Its closest competitor, Alibaba's (NYSE: BABA) Shenma, controls just 14% of the market.

Some investors might cite Tencent (NASDAQOTH: TCEHY) as a major competitor in advertising. However, Tencent generated just 14.1 billion RMB ($2.04 billion) in advertising revenues last quarter and makes most of that money from social networking platforms -- which don't directly compete against Baidu's search engine and portals. There were also concerns about Alphabet's Google returning to China with a censored search engine earlier this year, but that probably won't happen after the fierce public backlash against its leaked plans.

High growth estimates, low valuations

Analysts expect Baidu's revenue to rise 21% this year and 20% next year. On the bottom line, they expect its earnings to grow 11% this year and 13% next year.

Based on those estimates and a stock price of $200, Baidu trades at just 17 times next year's earnings. That makes it the cheapest stock in the BAT (Baidu, Alibaba, and Tencent) tech triumvirate. Alibaba trades at 20 times forward earnings, and Tencent has a forward P/E ratio of 28.

That's illogical when we consider that Baidu's core business faces less competition than Alibaba's e-commerce and cloud businesses or Tencent's gaming and social networking businesses.

Plenty of irons in the fire

Investors often seem to dismiss Baidu as a mature tech stock that's running out of room to grow, but the company still has plenty of irons in the fire. It has a first-mover's advantage in the driverless market with its Apollo platform, it's expanding its DuerOS virtual assistant platform to more hardware devices, it launched WeChat-like "mini programs" for its mobile app, and it still holds a majority stake in the popular streaming video platform iQiyi.

Baidu also isn't investing wildly in a wide range of companies like Tencent and Alibaba. Instead, it divested weaker and riskier businesses -- like its Global DU ad tools, Du Xiaoman financial services, and its stake in food delivery platform Ele.me -- to focus on the growth of its ad business, driverless/AI business, and the expansion of its mobile app ecosystem.

My take: Buy the dip

Baidu is often considered one of the safest Chinese tech stocks, and escalating trade wars and tariffs shouldn't seriously harm its core business. Therefore, I think investors with a longer investment horizon should buy Baidu at its 52-week low instead of rushing for the exits.

10 stocks we like better than BaiduWhen 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 quadrupled 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 August 6, 2018

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Baidu, and Tencent Holdings. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.