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Is Now a Good Time to Invest in Baidu?

Baidu (BIDU)Chinese Internet search company Baidu.com, Inc. (NASDAQ:BIDU) has taken quite the beating since releasing its third quarter earnings on October 29th, as disappointing revenues have pushed the stock down over eight percentage points in value. Looking to the fourth quarter, Baidu issued guidance ($979M-$1.01B) that is slightly off the Street’s top line consensus of $1.03 billion, and it’s quite possible that investors (like these hedge fund managers) are feeling skittish about these numbers as well.

Despite these issues, it’s important to note that the company did impress on the earnings front, coming in with a Q3 EPS of $1.37 versus $1.28 estimates. Last quarter’s earnings represent a near 50% growth from the same period a year ago, and the company’s third straight beat in 2012.

Assuming that Baidu can meet sell-side analysts’ EPS estimates of $1.29 a share, the Far East’s search giant would finish the year just 25 cents short of an even five buck-bottom line. Considering the fact that this is more than three times the level of earnings Baidu reported just two years ago, it’s easy to expect that its shares should be valued like a high-growth tech story, à la LinkedIn Corporation (NYSE:LNKD) or Facebook Inc (NASDAQ:FB). The fact of the matter is, though, they aren’t.

At its current market price just above $104 a share, Baidu trades at a historical discount in terms of nearly every metric under the sun, and is particularly under-appreciated when it comes to its growth prospects. Baidu is forecasted to grow its earnings by an average of nearly 42% a year over the next half-decade. This trumps its closest comparable Google Inc (NASDAQ:GOOG) by nearly threefold (15.7%), and is above regional peer Sohu.com Inc. (NASDAQ:SOHU) (11.6%) quite significantly.

Regardless of what cut-and-dry conclusions you’d like to draw about these numbers, don’t. Comparing Baidu to 2012-era Google isn’t a fair fight, as each search engine company is in a different stage of its respective life cycle, and smaller Chinese search provider Sohu isn’t really analogous either. The only way to truly determine if Baidu is worth investing in – assuming you follow the “earnings equals appreciation” school of thought – is to determine how the markets are valuing expected EPS growth. Luckily, we can do this fairly easily with the PEG ratio.

Using the same forecasts mentioned above, Baidu sports a measly PEG ratio of 0.56; typically any figure below 1.00 signals an undervaluation. Even more significantly, though, is just how cheap Baidu is in comparison to some of the biggest players in search. Google’s PEG ratio is 1.33 – modest, but not that as attractive as Baidu – and Sohu is nearly identical, at 1.30. LinkedIn and Facebook, which also operate in the Internet content and information industry, trade at PEGs of 9.61 and 7.16 respectively. Over a long enough time frame, every stock’s PEG should normalize.

In short, Baidu is expected to generate top-notch earnings expansion through at least 2017, and it appears that investors are still hesitant on giving the stock its fair worth. Let’s take a look at a few catalysts that can help Baidu’s shares reach their full potential, say, something in the $140-$150 range by next year, and $200 over the longer haul.

In the company’s most recent earnings call, its executives stressed that Baidu was in the middle of an exciting transition from desktop to mobile, and made it clear that they believed in their ability to dominate the future of this space. CEO Robin Li stated that Baidu’s future boiled down to three factors: “Staying ahead of industry developments, creating a seamless mobile Internet experience and growing mobile users and usage.” The first point is obviously the least to be concerned about, as Baidu’s sheer size gives it the utmost positioning in China’s search industry, but the latter two will be important for investors to track.

To get a bit more into the specifics, Li discussed that its mobile cloud platform was coming on strong, as already “over 100,000 developers have registered on the Baidu platform,” while making a point to mention the company’s superior Maps app. Unlike some other tech companies,

Baidu offers users indoor navigation guidance at their favorite theatres, malls, and supermarkets, and the proof is in the pudding; research firm Analysis International has “ranked Baidu Mobile Maps number one in daily active user accounts.”

Last but certainly not least, the company’s revamped HTML 5 mobile browser is the icing on the cake, garnering over 10 million users in its first few weeks. As Li put it himself, “the transition in search to a more mobile-centric model is well underway in China, as Baidu clearly isn’t comfortable just resting on its past successes. The company is making a big mobile push with a bevy of apps, cloud functionality, arguably the world’s best Map app, and a lightning fast mobile browser.

Adding in the fact that Baidu looks extremely strong on the earnings and valuation front, and it’s easy to be bullish on this stock. As we so often discuss here on Insider Monkey, some of the world’s best money managers are feeling particularly cheery about Baidu, including: Ken Fisher, Ken Griffin, Philippe Laffont, Tiger Global Management, and Richard Driehaus. For a complete look at the fund interest surrounding Baidu, continue reading here at Insider Monkey.

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