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Based on the post earnings sell-off of Baidu (BIDU), investors now get the opportunity to buy the market leader in the explosive Chinese market at a substantial discount to growth potential. While investors fret over the increased costs and the transition to mobile search, they missed the big picture that mobile will eventually lead to much higher traffic for a country with only 42% Internet penetration.

The company is the leading Chinese language Internet search provider with over 70% market share. As mentioned prior to earnings on February 4th, the company is an extreme value with strong growth potential.

The stock reached close to all-time highs last April around $150 and a market value of $55B. The stock fell off the China cliff until December and has returned back to those levels since the recent sell-off. While investors mull over more competition from Qihoo 360 Technology (QIHU), the real issue remains a market transition outside of the control of the company. The transition to mobile should ultimately expand the search market in China even if it reduces profit margins this year.

Q4 2012 Earnings Highlights

The company reported the following highlights for Q4:

  • Total revenues in the fourth quarter of 2012 were RMB6.335 billion ($1.017 billion), a 41.6% increase from the corresponding period in 2011.
  • Total revenues in fiscal year 2012 were RMB22.306 billion ($3.580 billion), a 53.8% increase from 2011.
  • Operating profit in the fourth quarter of 2012 was RMB2.848 billion ($457.1 million), a 24.0% increase from the corresponding period in 2011.
  • Net income attributable to Baidu in the fourth quarter of 2012 was RMB2.795 billion ($448.7 million), a 36.1% increase from the corresponding period in 2011. Diluted earnings attributable to Baidu per ADS excluding share-based compensation expenses (non-GAAP) for the fourth quarter of 2012 were RMB8.18 ($1.31).

Amazingly, the company reported a 42% increase in revenue for Q4, yet the market was unsatisfied with the forecasts of higher traffic acquisition costs.

Updated Earnings Estimates

Based on the guidance from the company, analysts have greatly reduced the earnings estimates for 2013 and 2014. As shown below, analysts now expect the company to earn $5.42 this year and $6.82 next year.

(click to enlarge)

* data obtained from

While the earnings growth expectations for 2013 have been greatly reined in, analysts still expect the company to report 30% long-term growth rates.

China Internet Growth

Unlike Google (GOOG) in the U.S., Baidu has the tailwinds of a growing domestic Internet market. While the majority of U.S. citizens are on the Internet, China only had a 42% penetration rate at the end of 2012 according to the China Internet Network Information Center. Of the 1.3B people in the country, only 564M are on the Internet so far.

Even more importantly, 420M people use the Internet via mobile phones. Over 74% of the Internet users use a mobile phone and that could be a different set of consumers. The major implication is that mobile provides a quicker and better opportunity for Chinese citizens to join the online world. Mobile traffic might have lower profit margins this year, but eventually it will lead to dramatically higher Internet penetration rates.

Google Comparison

Considering Google is virtually locked out of the China Internet search market, it is worthwhile to compare Baidu to that stock. With China becoming the 2nd largest economy and a threat to become the largest economy, it is worth considering that Baidu could eventually surpass Google.

Currently, analysts expect Google to report revenue of over $60B in 2013 while the stock is worth $260B. On the flip side, Baidu has a market cap of only $33B meaning that the stock would have to soar nearly 700% to eventually reach that level.

Analysts only expect the revenue for Baidu to reach $4.9B in 2013 though that is a 35% growth rate. Anybody thinking the company has reached a wall only needs to check out the size of Google. As long as Baidu remains the market leader in China, it will eventually reach those revenue levels.

1-Year Chart

The below chart compares the search engine giants over the last year:

(click to enlarge)

Conclusion

Baidu provides one of the best valuations in the stock market, no matter the market cap, yet the stock is one of the best known in the market. The long-term growth rate is more than double the price-to-earnings ratio. Investors won't find many similar valuations in the market. Conversely, analysts only expect 14% growth from Google though the stock trades at nearly 15x the forward earnings expectations.

No doubt exists that Baidu is the better valuation, yet investors have spent the last year piling into Google. When the momentum finally turns towards China stocks and Baidu specifically, this stock might be one of the biggest gainers in the market. Now isn't the time to run away from this Internet giant, but rather the time to research the best entry point. The stock is cheaper now after the major earnings-caused sell-off.

Source: Buy Baidu At Much Cheaper Prices Now

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.