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The history of Baidu, Inc. (NASDAQ:BIDU) is a story of aggressive growth and strong outperformance. The stock has rallied 860% since 2009 in a move that has added around $35 billion in shareholder value to the organization. For the past year, however, this growth has been stunted and the stock price has declined nearly 30%. Through this article, I will present the case that Baidu is poised for further growth in the near future and investors looking to purchase could potentially do so, while minimizing their risk exposure.

A History of Returns

Baidu has delivered solid performance not only from a share price standpoint, but also from a balance sheet perspective. Two key ratios that embody the fundamental performance of an organization are return on assets and return on equity.

Return on assets is the profit of the firm divided by the assets the firm utilized to drive its business. This ratio essentially informs the analyst about how efficient the organization is at using its assets to generate profits.

Return on equity is a ratio that is calculated by dividing net income by directly-invested shareholder equity. This figure allows the analyst to quantify the level of returns that original shareholders are currently earning on their invested capital.

Click to enlarge

The chart above shows five years of return on assets and return on equity for Baidu. Investors who have been simply examining changes in stock price or looking at new ways that Baidu is bettering its competitive platform have missed this excellent picture. For the past five years, Baidu has become progressively better at turning its asset and investments into profits for the firm.

Between the years of 2007 and 2008, return on assets and return on equity consistently grew until these ratios leveled off in the middle of 2009. Beginning in 2010, Baidu once again generated new heights of performance and in late 2011, performance began to decline.

It is very important to note that while performance has started a declination over the past three quarters, current levels are still exemplary. As it stands, for every $1 of assets the firm owns, it is generating $.38 in net income. This is a very strong ratio and shows that while performance has slightly declined in recent quarters, Baidu is still a competitive entity.

Margin is Key

Another key ratio that embodies the fundamental performance of Baidu is profit margin. Profit margin is a figure that basically tells the analyst how many cents of each dollar of revenue the firm is able to keep as profit. Profit margin is very important in that it describes how well a firm is currently able to defend its competitive edge.

For example, if a firm is required to spend millions defending its patents or developing new products to match its rivals, profit margin will be small due to the added expenses or decreased revenues from competition. However, if a firm is essentially unchallenged, it will not need to spend as much on researching new products and will be able to keep a greater percentage of the market as its customers.

The chart above shows five years of profit margin history for Baidu. The trend is in profit margin is undoubtedly increasing. What this increase in margin practically means is that as time progresses, Baidu has shown itself able to consistently keep a greater percentage of revenues as profit. This means that Baidu has substantial breathing room to continue defending its lead against competition should rival firms attempt to wrest market power from it.

Until now, the analysis has been fairly straightforward. We have demonstrated that Baidu is performing well from a return standpoint as well as delivering a healthy profit on its operations. However, there is one additional element that I believe the market has missed in its recent examination of Baidu. During the previous quarter, Baidu decreased its performance in return on assets and return on equity. This decrease in performance translated into a share price decline of around 20%.

It appears as though the market ignored one key fact about Baidu and that is its profit margin. In the previous quarter, Baidu delivered a 50.77% profit margin. This profit margin is excellent, however the number is not what's important. Notice in the chart above that this profit margin represents the first substantial increase since performance began declining in 2011. Not only is this increase substantial, but it also has driven the firm to all-time heights of business success.

The trend in growing profit margin marked a strong resumption in upwards growth by knocking out a two-year high. I believe the market has chosen to focus more on the volatile business environment and competitor action rather than examining the fundamental performance of the organization. As profit margin clearly shows, the firm became stronger last quarter while prices declined. This decoupling in market perception and firm performance represents an investment opportunity.

Technically Speaking

No matter the strength of the fundamental argument, we should always be cognizant of the technical picture of the stock price. By studying the current trend and major support and resistance levels, we can best position ourselves to capitalize on an investment thesis. The chart below provides a technical picture within BIDU.

As can be seen, price is falling within a trading range. This decrease in price represents a good opportunity to participate in our fundamental thesis, while minimizing risk. If price falls below $100 per share, then the major uptrend will have ended and price will technically be in a downtrend. However, if price is able to overcome the descending trend line, then a new uptrend will be in motion.

As it stands right now, investors are afforded two opportunities. The first opportunity is to wait for the trend line to be broken. I believe this will happen around $125 per share, and if price is able to overcome this point, then I believe a purchase is warranted.

The second opportunity is to be aggressive and purchase now. If investors purchase now, the stop loss for this trade ($100 per share) will be closer which paradoxically means that aggression now will ultimately result in less risk on the trade. These two choices each represent viable purchasing opportunities in a fundamentally sound organization. As long as the price remains above $100 per share, I view this analysis as valid.

Source: Baidu: The Market Is Missing The Bigger Picture