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Baidu's Persistent Search for Growth

Kevin Cook

Baidu, Inc. (NasdaqGS:BIDU - News), the leading Chinese language Internet search provider, announced Monday its financial results for the second quarter with profit that beat estimates by 9%. The company, which provides innovative search results for 75% of China's 477 million online users, reported diluted EPS of $0.72 when the Wall Street consensus expectation was $0.66.

Highlights from the company press release...

Total revenues: $528.4 million, a 78.4% increase from the corresponding period in 2010.

Operating profit: $287.5 million, a 91.2% increase from the corresponding period in 2010.

Net income: $252.6 million, a 95.0% increase from the corresponding period in 2010.

'Baidu had another excellent quarter, as we benefited from strong traffic growth and improved monetization,' said Robin Li, chairman and chief executive officer of Baidu. 'We were especially encouraged with the strong spending from large customers, highlighting the increased value they saw from their marketing spend on Baidu.

'We continued to see strong momentum and product integration from our Box Computing open data and application platforms during the quarter,' Mr. Li continued. 'Our position at the center of China's Internet ecosystem enables Baidu to benefit from key trends such as the growth of e-commerce.'

Ideal Growth

Baidu was founded in 2000 by Internet pioneer Robin Li, creator of visionary search technology Hyperlink Analysis. According to the company, 'Our name was inspired by a poem written more than 800 years ago during the Song Dynasty. Baidu, whose literal meaning is 'hundreds of times,' represents a persistent search for the ideal.'

The earnings beat by Baidu represents the fourth consecutive such surprise, with a quarterly average in the last year of 8%. While the consistent earnings surprises are impressive, what is even more remarkable is the consistency of the magnitude of those beats, hitting 7.1%, 8.7%, 6.8%, and 9.1% in the last four quarters.

This implies that the company guidance is consistently accurate such that analyst projections are nearly in line with actual results. And this close watch by the analysts is reflected perfectly in the stock's price appreciation for the past year, as shares more than doubled from $80 to today's new all-time high above $165.

The stock now trades at a 1-year forward P/E multiple north of 60 times, but only 40 times 2012 estimates.

This makes sense to us at Zacks because we know that upward trends in earnings estimates are the strongest driver of stock buying by institutional investors. Here's a snapshot of the earnings picture that analysts saw going into Monday's report by the company. If the trend continues, we should see projections rise for the rest of this year and next.

And here's what I wrote on July 5 in 'Baidu vs. Google: Searching for Growth' as BIDU traded around $145 and Google (NasdaqGS:GOOG - News) was fighting to get back to $550 after disappointing investors in the first quarter...

BIDU Rides a Wave

'Baidu shares continue to climb strongly on the support of their 50 and 200-day moving averages. But that's just the consequent effect of the real driver. The underlying cause of the ascent is the earnings growth trend that attracts institutional buying.

I was fond of BIDU last October as it attempted a breakout above $110 and I saw it as dominating its very own captive emerging market. I recommended a March 2011 100/130 bull call spread for $12 then, but I missed the pullback last month to support at $115.

Actually, both GOOG and BIDU had great long entry opportunities in late June as the market recovered. But if you could only pick one web search giant, which should you go with?

You want to go with the higher earnings strength. BIDU has held a Zacks Rank of #3 (hold) or higher since January of 2010. And betting on that strength would have paid off nicely as BIDU handed you a 25% gain from the June lows while GOOG only returned 10%.

When you are taking risks in the market, make sure you are doing it with names that are worth it. Earnings strength is, as always, the safest key.'

Endless Quest

Baidu was able to significantly increase its share of the search market when Google exited last year by moving its 'engines' to Hong Kong as a sign of protest against government censorship policies. But that growth has leveled off now with the increase from the previous quarter totaling only 0.1% to hit a 75.9% share.

Still the company was very excited about search advertising growth as the number of online marketing customers climbed 17% to nearly 300,000 and the revenue per customer rose 53%.

The question now is 'Can Baidu sustain this rapid pace of earnings growth on advertising revenue alone, especially since its market share of online users probably won't grow much more?'

Knowing the limitations of search advertising revenue, Jennifer Li, Baidu's chief financial officer, commented, 'Our top and bottom line results grew strongly again this quarter, with healthy increases in overall traffic and paid click growth. We will continue to accelerate our investments in strategic areas, R&D, network infrastructure and bringing new talents on board to drive long term growth.'

In this vein, as MarketWatch.com's Joan E. Solsman reported Monday night, 'Last week, Baidu released an Internet browser, and earlier in the month, it formed a joint venture with Japanese telecom operator NTT DoCoMo Inc. to distribute games and other mobile phone content in China.'

Persistent Search for the Ideal

The coming week or two of analyst reports and estimate revisions will tell us if Wall Street likes this growth strategy and believes it promising. In the meantime, it's no wonder that Baidu is able to dominate China's Internet search market by providing services to over 340 million citizens.

Just read this statement from 'The Baidu Story' page on their website to get an idea for why a Chinese company may best know how to speak to its own people in the most subtle and personal of ways that likely builds lasting customer relationships...

'Our deep understanding of Chinese language and culture is central to our success and this kind of knowledge allows us to tailor our search technology for our users' needs. Just to cite one example, we believe there are at least 38 ways of saying 'I' in the Chinese language. It is important that we recognize these nuances to effectively address our users' requests.'

You know how we get attached to our web browsers? I mean they don't call it the 'home' page for nothing. Sounds like Baidu understands that user experience.

Kevin Cook is a Senior Stock Strategist for Zacks.com

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