When a company grows fast, it attracts a lot of attention. Investors buy the stock, the company reports fantastic growth, and the stock gains momentum. However, at some point, analysts begin to question how long the company’s growth can last. There are generally two directions a high growth business can go.
One possibility is, the company expands its business into other industries, diversifying its revenue streams. The second is, the company runs into problems and begins to lose market share to its competition. These are the two possibilities facing Baidu.com, Inc. (NASDAQ:BIDU). Either the company expands and continues to grow or it becomes just another Internet company.
Searching for growth
The investing premise behind Baidu used to be very simple. Baidu was and is the dominant search company in the Chinese market. In theory, Baidu.com, Inc. (NASDAQ:BIDU) should have the same opportunities as Google Inc (NASDAQ:GOOG). If investors are willing to pay 20 times projected earnings for Google’s expected 15% earnings growth, then why wouldn’t investors pay an equal premium for faster growth at Baidu?
Not long ago, analysts were calling for 40% EPS growth from Baidu over the next few years. The stock was valued at about 30 to 40 times projected earnings, and the comparison between Baidu and Google made sense, while other competitors like Sohu.com Inc (NASDAQ:SOHU), were only expected to grow earnings by 15%. At the time, Baidu.com, Inc. (NASDAQ:BIDU) seemed unstoppable and the stock rose like a rocket. Some thought that if Google Inc (NASDAQ:GOOG) could grow earnings by 15% in a saturated United States market, Baidu should easily be able to grow at a faster clip in a Chinese market with about one-third the internet penetration.
As Baidu’s market position seemed unassailable, an upstart anti-virus company Qihoo 360 Technology Co Ltd (NYSE:QIHU) decided that it didn’t like the status quo. Qihoo began offering search results to its anti-virus users, and Baidu seemed to be caught off guard.
Today, Baidu.com, Inc. (NASDAQ:BIDU) is spending money in hopes of not only countering the Qihoo threat, but its also trying to take over the mobile game in China. If mobile is the future of Baidu’s growth, China’s huge population and well-connected mobile user base should serve the company’s aspirations well. The real question investors must ask is, what must Baidu do in order to regain its lost momentum?
4 key metrics
There are a few things investors can look for in Baidu’s next earnings release to determine if the company will regain its momentum. First, the hallmark of Baidu.com, Inc. (NASDAQ:BIDU)’s growth story has been strong revenue growth. In its last earnings report, the company reported a 40% jump in revenue. Even if sales growth were to slow, it seems reasonable to expect that the company can grow earnings by around 20% per year. If Baidu is to maintain its growth trajectory, it’s absolutely critical the company continues to grow its top line.
A second item that investors should be on the lookout for is, continued strength in both online marketing customers and revenue per customer. Baidu reported an increase of 27.7% in active online marketing customers and revenue per marketing customer increased by 9% last quarter. Any significant slowdown in either of these numbers would spell trouble.
The third issue, was a painfully obvious problem for Baidu.com, Inc. (NASDAQ:BIDU) last quarter. The company’s spending in the areas of SG&A and R&D expenses seemed a bit out of control. If we compare Baidu’s SG&A expenditures as a percentage of revenue, the numbers don’t look that bad. The company spent 14.21% of revenue on this line item.