Everybody seems to be very bullish on Google (NASDAQ:GOOG) and Baidu (NASDAQ:BIDU) and there is no reason not to be. Both companies have very high growth expectations, a strong presence in their respective markets, and are featured in SmartMoney's top ten stocks for 2012. In this article, I explain why Google is currently the better buy.
In 2011, Google shares went up by 7.7% at the close of December 28th, which is great compared to the Nasdaq's 2.4% loss on the year. Trading at a current P/E ratio of 21.8 and a 1 year forward P/E ratio of 14.6, Google looks like an excellent value buy if its strong growth can continue. Google's EPS is expected to grow by 24.5% in 2011 and 19.2% in 2012, which is remarkably high considering how big the company has already become.
Google is also a great way to get invested in markets that only grossly overvalued tech darlings occupy otherwise. The company has consistently demonstrated its ability to take over markets it enters and there is no reason to not believe that this trend will continue. Google + is expected by many to challenge Facebook, Google Offers could easily beat out Groupon (NASDAQ:GRPN), and its acquisition of Zagat suggests the company is positioning itself to compete against Yelp. With the amount of music on YouTube, Google can probably make a play to compete against Pandora (NYSE:P) and with its search and mapping capabilities, it can easily outcompete companies like Angie's List (NASDAQ:ANGI) and Zillow (NASDAQ:Z). In my opinion, Google offers about $35 billion in value with these services when compared to the valuations of competing tech darlings, and none of these ventures currently contribute to Google's earnings. Take into account that Google has over $38 billion in net financial assets that also don't contribute to earnings and Google's current P/E ratio for only products that produce earnings is around 14.1, making the company look like an even better value buy in today's market.
From a P/E standpoint, Baidu is slightly more expensive. The company currently trades at 44.8 times earnings and has a 1 year forward P/E ratio of 26.5. Because the company is profitable and has such remarkable expected earnings growth, I believe the high earnings multiple is highly justified and the stock will maintain its high valuation if it can modestly improve earnings.
Baidu already controls over 75% of the Chinese internet search industry (similar to Google's U.S. presence) and the growth expectations stem from more people in China having internet access. Currently about 80% of Americans use the internet, while only about 36% of Chinese use the internet. The American number should increase as more of the population uses computers during childhood, while the Chinese usage should increase as more people in China can afford access to the internet. In addition, Baidu has the ability to see into the future as what is happening in the Chinese market has already happened in the American market. The company can essentially be seen as Google in a developing market.
When comparing the two companies, both are similarly priced from a value standpoint. However, I picked Google over Baidu because of the risks that investing in Baidu poses. I have pinpointed three major risks and they are:
- Baidu's Ability to Hold Market Share
One thing that baffles me about search engines is how people generally stick with one search engine when it is fairly easy to switch from one to another. Just as Google competed with Yahoo (NASDAQ:YHOO), MSN (NASDAQ:MSFT) and Ask Jeeves, Baidu has to compete with the likes of Alibaba.com (OTC:ALBCF) and Sohu.com (NASDAQ:SOHU). Just because Google won its war does not necessarily mean that Baidu will do the same. Google backed out of the Asian market for a reason and Yahoo is looking to follow. Looking into the distant future, I believe that Google is much more likely to hold its market share than Baidu.
- Government Intervention
I trust the U.S. Government a lot more than the Chinese Government. Baidu and its competitors are one scandal away from being censored by China and just a week or two of censorship can mean the end for any of them. Another risk involves tax rates. Google has generally paid a much higher tax rate then Baidu. Chinese corporate taxes are much more likely to go up than down and American taxes are much likely to go down than up, and this is very important to consider from a shareholder's perspective.
- Chinese Growth Prospects
China does have a growing economy, but there is a lingering question of how long it will take China to catch up to America in internet usage. The competitive advantage of Chinese manufacturers is cheap labor, and if that labor becomes more expensive, the economy can take a hit. I believe that nobody can accurately predict China's long term growth. It is not as difficult to forecast American growth and even if America faces a huge economic downturn, the U.S. will still be developed enough for internet access numbers to stay stable. If Chinese internet access growth slows even 5% below analyst expectations, Baidu's earnings can take up to a 20% hit.
As I mentioned in the opening paragraph, both Google and Baidu are good stocks to have in a portfolio right now. I currently put a strong buy recommendation on Google and a buy recommendation on Baidu. The risk factors mentioned above are not extremely likely, but they are still big risks. And if any of them come to fruition, investors in Baidu will take big losses. Right now, Google is simply a better stock to own and it will be fun to monitor what happens to both companies and their stock prices in coming years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.