Baidu vs Google The Search for the Best Investment

Recently, Stock Rover CEO Howard Reisman did a webinar ^[1] on his 12 favorite large cap growth stocks. Since I have been following the performance of Chinese search engine provider Baidu (BIDU), another very rapidly growing large cap stock, I was curious to see how it stacks up against Howard’s picks. Thus, I added BIDU to Howard’s watchlist and screened it using his personalized “17 Factor Growth Stock Ranker”? screener, which ranks stocks according to the criteria below (the value on the right indicates the weight that metric is given):

According to the results, shown below, Baidu comes in third, beating out even Google (GOOGL), the world’s leading search engine, which places sixth.
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Intrigued by these results, I decided to look a little deeper into both stocks to see whether BIDU really is a better growth stock than GOOGL, as the screener suggests, or whether there are additional factors such as business structure and market position that give Google the edge.

Growing by the Googolplex

Let’s start off by parsing those growth numbers, as they make up the highest-weighted category in the screener.

The metrics Howard uses for the screener (above) are Sales 5-year Average annual compounded growth, EPS 5-year Average annual compounded growth, and the expected EPS Next Year earnings growth. From these metrics, it is clear that Baidu’s growth is far outpacing Google’s growth, at more than double Google’s rate. However, this is largely due to Baidu’s position in China, an emerging market that is far from saturated with only 42.3% of the population listed as Internet users as of 2012.

For good measure, I also looked at each company’s yearly sales and EPS growth.

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Google is a much larger business than Baidu, currently generating eight times Baidu’s revenue, as seen in the bar chart above. Thus its market cap is also much larger at roughly 390 billion, dwarfing Baidu’s 65 billion. That said, Baidu’s sales growth has consistently been higher than that of Google’s, as seen above.

Though both companies have had strong double-digit sales growth, they have both seen dips in the 2013, with Google’s continuing into the current year. This decline is mostly driven by a revenue mix that is increasingly skewed toward mobile advertisement sales, which typically bring lower profits than desktop ads due to decreased screen size and slower connection speeds. Lower sales growth numbers over the past couple of years shouldn’t put off investors, however, since both companies are making efforts to better monetize their mobile platforms (which I discuss later on) and expect to see sales growth pick up next year. In fact, Baidu’s revenue growth of 59% year over year (YoY) for 1Q14 is a promising sign of its strong sales growth going forward.
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The yearly EPS growth trends (above) tell a more complicated story. Though Baidu has seen exceptionally high EPS growth up until two years ago, it fell behind Google last year with an EPS change of only 0.4%. This is most likely due to heavy spending on investments, in particular Baidu’s purchase of 91 Wireless, China’s largest third-party mobile applications distribution platform, for 1.9 billion in August 2013, which no doubt put a dent in its earnings.

Google’s EPS growth has been on average slower and less volatile than Baidu’s, but it has also had its ups and downs, hitting a low two years ago. Investors should be happy to see, however, that both companies’ next year EPS growth estimates look highly promising.

An Income-ing Query

Let’s check into each company’s financial statements to gain some insight as to what is going on behind their EPS numbers.
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Despite increasing net income, operating income, and EBITDA, Baidu’s income statement (above) shows decreasing margins, another sign of its recent spending to stay ahead of competition and maintain its position as China’s dominant search engine. Even so, Baidu’s margins are still at a very healthy range, and Morningstar analysts predict that its operating margins will stabilize by 2015 and recover to 32.9% by 2017.
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Google’s income statement (above) shows much the same trend – it is increasing its earnings but also its expenditures, as evidenced by decreasing net, operating, and EBITDA margins. Its gross margin has remained fairly stable over the past year. While its margins are a bit lower than BIDU’s, they are also nothing to worry about.

Baidu’s balance sheet (below) looks clean as well. Though its debt is increasing, it still has significantly more cash and a healthy debt ratio of 0.5.
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Google’s balance sheet (below) displays a huge amount of cash and a very low debt/equity ratio of 0.1, which attests to its significant liquidity. Its debt has been climbing over the years, from $0 in 2010, which corresponds with increased spending in several areas including the mobile platform development and acquisitions.
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As can be seen below, each company’s cap ex, research, and intangibles metrics confirm that they have indeed put an increasingly substantial amount of money into technological investments and acquisitions relative to their cash on hand. The dramatic increase in intangibles, especially, points to the acquisitions that both Google and Baidu have been making over the past two years.

Financials reveal that the two companies are acting similarly by investing in their businesses, though Google is doing so on a larger scale. And since both have healthy margins and cash to spare, this should lead to earnings growth in the future, once spending stabilizes. No clear winner has emerged yet—both are looking strong.

Valuation: Does the Price Click?

The next highest-weighted category in Howard’s screener is valuation. It’s important to consider valuation when evaluating high-growth stocks, since their prices can sometimes be inflated by investor sentiment. The two values Howard uses to measure valuation are EV/EBITDA and PEG. Since the stocks in his watchlist have widely varied business structures, it makes sense to use EV/EBITDA, which normalizes debt structure. For further insight, I’ve also included Price/Earnings and its industry decile for the Internet Content & Information industry (a lower decile score indicates better performance relative to the industry):

With a lower P/E and an EV/EBITDA almost half that of BIDU’s, GOOGL looks quite a bit cheaper according to the table. Although, compared to their industry, both companies are inexpensive, and their relatively low PEG forward of 1.4 suggests that their high expected growth in the coming year will justify their pricing.

Browsing Through the Results: Capital Efficiency

Given growth, financials, and valuation, it’s pretty hard to peg either GOOGL or BIDU as the winning search engine stock. Perhaps efficiency metrics, which constitute 20% of Howard’s screener, will help differentiate. The four metrics below measure whether a company is making effective use of its capital.
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Here as well, Baidu and Google’s efficiency metrics have moved similarly. Their ROICs have both shown a parabolic trend, increasing and then decreasing in recent years. Their ROA vs. Industry, ROE vs. Industry, and Operating Margin vs. Industry metrics have jumped around a bit but have also gone down recently. I am interpreting these efficiency metrics to mean that both companies’ heavy investments as of late have yet to pay off. Overall, both companies are doing better than the industry, with Baidu’s numbers slightly higher than that of Google’s.

Search (Stock) History: Price Performance and Momentum

Finally, let’s take a look at price performance and momentum metrics, which count for 15% of Howard’s screener.
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The results above are quite interesting – Baidu has been performing better than Google for the past three months as well as the past five years, yet its two year returns are not only lower than Google’s but the industry’s as well. Currently, both companies are performing well, with prices near their 52-week highs.

To see where these numbers are coming from, I charted BIDU’s and GOOGL’s price changes over the past two years and the past five years with their industry as a baseline (the flat blue line in both images):

 

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The price and momentum metrics show that BIDU’s overall growth has exceeded that of GOOGL’s, but it has lost momentum over the past two years and is only recently picking up. Thus, BIDU offers investors a higher absolute return, but only if they are willing to go along for a wilder ride, while GOOGL, as a larger and more mature business, offers a steadier path.

The Algorithms for Growth

Baidu is clearly growing faster than Google and making higher returns, but how long will it be able to keep up its stellar performance? Does it have the ability to grow in the long run? And will Google be able to maintain its strong double-digit growth? To answer these questions, let’s examine each company separately:

Baidu:

Growth Overview

Google:

Overview

Conclusion: Who has the better algorithm for investors?

There is little doubt that BIDU and GOOGL are both excellent companies. BIDU is sure to see continued rapid growth in the next few years, as both its business and its market have yet to mature. In fact, BIDU’s short-term returns are likely to outpace GOOGL’s. Even so, I would choose GOOGL over BIDU as a long-term investment. GOOGL has proven its ability to make consistent profits, even as its search business has matured, through its creative technological improvements and strategies for growth, plus its diverse array of products and penetration into international markets make it a safer choice as well. As both companies have been funneling money into growth initiatives lately, it will be interesting to see how their investments will pan out in the future. After all, their decisions have an impact not only on investors’ portfolios but also on the everyday life of a human in the 21st century.