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Better Buy: Baidu vs. NetEase

Rick Munarriz, The Motley Fool

Some of China's earliest publicly traded online companies are getting pretty cheap. Baidu (NASDAQ: BIDU) -- the country's leading search engine provider -- is hitting six-year lows this summer. The stock is now trading for just 16 times next year's projected earnings. NetEase (NASDAQ: NTES) is faring better, but the online gaming pioneer has surrendered nearly a third of its value since peaking two years ago. NetEase shares can be had at 19 times next year's profit target.

Stocks trading at forward earnings multiples in the high teens aren't automatically bargains, but Baidu and NetEase have historically traded at far juicier ratios. The two stocks have been big winners for long-term investors. Baidu has soared 1,130% and NetEase has skyrocketed 2,150% since being initially recommended in Motley Fool Rule Breakers in 2006 and 2004, respectively. Let's see which Chinese dot-com is the smarter investment for the year ahead. 

Graphics from one of NetEase's flagship games.

Image source: NetEase.

Getting back on track

Baidu and NetEase aren't in ideal situations at the moment. Baidu's business has decelerated dramatically, as China's slowing economy has cooled budgets for paid search leads. NetEase saw its revenue slow to a crawl since early last year when regulators clamped down on China's gaming industry, but it has since started to bounce back. Analysts see NetEase revenue accelerating next year for the first time since 2015. 

Each company is facing unique challenges, but both Baidu and NetEase are struggling with their signature businesses. Baidu's online advertising business has seen its revenue growth turn negative, and revenue from continuing operations rose 6% in its latest quarter. Overall profitability is going the wrong way. NetEase is holding up relatively better, as revenue and earnings rose 15% and 20%, respectively, in its latest report. However, the online gaming business that contributes 61% of the top-line mix at NetEase still saw its growth rate come in at less than half of what it was achieving in each of the three previous quarters.

Buying into Chinese stocks is risky these days. Trade tensions and a slowing economy in the once red-hot nation are weighing on investor appetite for the country's former market darlings. For now, NetEase is the one that's better situated to deal with the new normal, and it also rewards investors with a modest, yet tangible, dividend that currently works out to being a 1.6% yield.

If investors think that the rocky times will continue, NetEase has proven the more apt of the two in navigating through this rocky terrain. However, if you feel that the tariff standoff with the U.S. will be resolved sooner rather than later and that China's economy will eventually right itself -- and both of those things are just a matter of time, one would think -- then Baidu is positioned for the bigger bounce.

Both companies have the well-entrenched businesses and pedigree papers to beat the market once conditions stabilize, but if and when investors get hungry for Chinese equities again it will likely be Baidu leading the way. 

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Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Baidu and NetEase. The Motley Fool has a disclosure policy.

Better Buy: Baidu vs. NetEase was originally published by The Motley Fool