Buy Baidu.com, Inc. (ADR) (BIDU)?

In the last three months, Chinese search engine provider Baidu.com, Inc. (ADR) (NASDAQ:BIDU) has seen a dramatic 20% drop in share price. As recently as April 9, The Motley Foolwarned that the number of internet users in China may begin to slow, which could become a threat to Baidu’s growth. Other outlooks are equally foreboding. International Business Times offered a similarly dismal outlook, explaining, “increased selling has led Baidu.com, Inc. (ADR) (NASDAQ:BIDU) stock to under-perform relative to its peers and sector, year-to-date.” Finally, The Motley Fool expanded on their already grim prognosis by later adding, “Baidu’s fallen out of favor since Qihoo 360 Technology Co Ltd (NYSE:QIHU) introduced a rival search engine last year.” Yet, while the Chinese may not have great affinity for an underdog story, it is one Americans love, and it’s the very reason we should not yet cast off the prospect of Baidu offering incredible long-term potential.

The Google of China

China’s Baidu.com, Inc. (ADR) (NASDAQ:BIDU)By examining how Baidu.com, Inc. (ADR) (NASDAQ:BIDU) stock performs on the five major value metrics of P/E ratio, P/B ratio, debt/equity ratio, free cash flow, and PEG ratio, we can see why Intel Corporation (NASDAQ:INTC) has confidence in Baidu. The companies have decided to partner in an effort to develop software for the Chinese mobile internet market.

One of the quickest and most frequently used metrics in gauging the value of a stock is the price/earnings ratio. Today, Baidu has a healthy P/E ratio of 18.4 (ttm), compared to an industry average of 27.5. This tells us that many investors are not expecting growth from Baidu the way they are from the average company in the technology sector. However, investors can expect to pay less per share of Baidu.com, Inc. (ADR) (NASDAQ:BIDU) for each dollar of earnings, and as the other metrics will show us, the prospects for healthy earnings are strong. This may be evident in understanding the investor’s outlook via the price/book ratio.

As we look at the price/book ratio of 7.5 (ttm), we see that investors are paying over seven times the book value per share. This ratio, like so many others, is most useful when compared to other companies that are similar to Baidu. In this case, the comparable price/book value for the technology sector is 3.9 (ttm). Some may be wary of purchasing a share for a multiple so far above the sector average, but it is important to remember that a company like Baidu.com, Inc. (ADR) (NASDAQ:BIDU) has an enormous amount of value wrapped into intellectual property that would not so readily translate into the assets used to calculate the price/book ratio.

Additionally, a review of Baidu’s book value per share shows a clear increase year-over-year. Consider that the book/value per share in 2008 was $1.31, versus $11.94 in 2011, and the most recent value of $12.02 (ttm). This may underscore the recent expansion of the company in the U.S. and its ongoing investment in technology. Earlier this month, Wired discussed Baidu.com, Inc. (ADR) (NASDAQ:BIDU)’s new office in Cupertino, California, which represents the company’s expansion into the U.S.  Additionally, the company is establishing a new research lab, which is dedicated to ‘deep learning.’

Competitors and future investment

The picture of Baidu.com, Inc. (ADR) (NASDAQ:BIDU) comes into greater focus as we move forward and look at the debt/equity ratio. This measure is useful in determining to what extent a company is financing its growth through the use of debt. For Baidu, this number is 0.4 (ttm). As a result, we see a company that faces a lower burden of meeting heavy debt obligations. This, in turn, represents lower risk, relative to others in the technology sector that represent higher debt/equity ratios. Other competitors, such as Tencent Holdings and Sohu.com Inc (NASDAQ:SOHU), have comparable ratios of 0.2 and 0.1. For those who are unaware, Tencent provides services related to internet, mobile and telecommunications, and other online value-added services in China. While the company is relatively unknown in the U.S., it is well-known in China as has been rapidly expanding over the last few years.  Sohu, meanwhile, provides online services in China, and is most well known for sohu.com, which provides news, commentary entertainment, and more. Both Tencent and Sohu.com Inc (NASDAQ:SOHU) are near 52-week highs and have strong outlooks moving forward, as they have plenty of room to grow and continue to increase revenues. However, despite these strong numbers and overall attractive companies, neither of these companies can boast owning 73% of the Chinese search engine market and a valuable growing relationship with Intel Corporation (NASDAQ:INTC); this fact alone gives Baidu.com, Inc. (ADR) (NASDAQ:BIDU) an advantage.

Partnerships and expansion like this are only possible through free cash flow. This measurement is a more reliable metric that is extremely difficult to manipulate through clever accounting. Through free cash flow, we can see how Baidu is able to generate cash. The company has seen its free cash flow increase by 56% from 2010 to 2011, and 61% from 2011 to 2012. This gives Baidu incredible opportunity to continue its already aggressive growth through investment in technology. With free cash flow, the company displays its ability not only to generate cash, but also develop other services like Baidu News, Baidu Space, and China’s largest online encyclopedia (by users), Baidu Encyclopedia. The expansion of technology is among the most critical for a company in this web sphere.

Finally, the price/earnings to growth, or PEG ratio, of Baidu.com, Inc. (ADR) (NASDAQ:BIDU) (0.55) indicates the stock is undervalued. To bring greater meaning to the price/earnings-to-growth ratio, consider the results of a brief study conducted by Motley Fool researcher Joseph Khattab, who calculated the PEG ratio for 1,316 companies. He discovered that 92% of companies with a PEG ratio of less than one enjoyed returns greater than the market for three years.

Final thoughts

By looking at Baidu from these five different vantage points, we can construct a multi-dimensional view of the current and projected value of a company that is poised to deliver exceptional returns in the future. The recent share price decline is not something to be fearful of, but instead a great sign of opportunity.  Additionally, Baidu.com, Inc. (ADR) (NASDAQ:BIDU)’s large market share advantage over competitors such as Tencent and Sohu gives it an immediate leg up, and to many, this fact alone makes Baidu a better investment. Plus, shareholders can realize even greater value by purchasing at a discount and becoming owners of an already-valuable company.

The article Baidu: Why Now Is The Time To Buy originally appeared on Fool.com and is written by Daniel Murray.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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