Baidu Inc (ADR) Stock Just Dipped Into Undervalued Territory

Weakness in the big growth tech sector has created an opportunity in Baidu stock

Can Baidu Stock Rally 40% This Year to $250? Here's What To Focus On

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Markets have been weak lately, led largely by a downfall in technology stocks. From the data leak at Facebook, Inc. (NASDAQ:FB) to Nvidia Corporation (NASDAQ:NVDA) suspending self-driving tests following a fatal Uber accident in Tempe to insider selling at Tencent Holdings Ltd (OCTMKTS:TCEHY), the near-term picture in tech is pretty blurry right now.

But looking past the near-term haziness, many of these companies are still supported by strong long-term fundamentals. The key, now, is to find big growth tech stocks that have plunged into undervalued territory.

One such stock is Chinese digital search giant Baidu Inc (ADR) (NASDAQ:BIDU). BIDU stock has been pounded recently. It has fallen from $265 to $220 in a matter of days.

But down here at $220, Baidu stock looks materially undervalued. The company has huge growth prospects through China’s digital and mobile advertising markets. And those growth prospects are underappreciated at the current stock price.

As such, if you’re looking for opportunity in this tech sell-off, I think BIDU stock is good place to start.

Here’s a deeper look:

Baidu Stock Has Growth Written All Over It

For all intents and purposes, Baidu is the Chinese Alphabet Inc (NASDAQ:GOOG)(NASDAQ:GOOG).

That is an exceptionally favorable comparison. As the de facto digital search giant globally, Google has become a cornerstone of the internet. After all, what is the internet without search? Not much. That is why Google processes 3.5 billion searches per day.

Google is a $100 billion-plus revenue company growing at a 20%-plus clip. Baidu won’t ever get to that level. The Chinese search giant is largely constricted to the Greater China market, so its addressable search and advertising market is far smaller than Google’s addressable market.

But because Baidu only has $13 billion in trailing 12-month revenues, there is significant room for growth ahead for Baidu stock.

The digital advertising market in China is experiencing explosive growth right now. Most of that is due to the massive boom in Chinese consumerism that is currently taking place. Long story short, China’s giant middle class is benefiting from rising incomes and subsequently urbanizing. This urbanization means an explosion in digital usage, commerce, travel, and all things consumer-related.

This trend is just getting started. Only 50% of Chinese consumers are on the internet. In the U.S., roughly 90% of people are on the internet.

Thus, there are still several innings left in the China digitization narrative.

Baidu Stock by the Numbers

For Baidu stock, that means current 20-30% revenue growth rates are here to stay for the long haul. At worst, BIDU grows revenues at a 20% clip over the next five years (20%-plus has been Google’s growth rate for a long, long time).

From last year’s $13 billion revenue base, that would imply revenues of over $32 billion in five years. Margins should head higher over that time frame, but to be conservative, let’s assume operating margins remain flat at 23-24%. A 23.5% operating margin on $32.4 billion in revenues translates to $7.6 billion in operating profits. Taking out 20% for taxes and dividing by presumably 350 million shares, you get to roughly $17.40 in earnings per share in five years.

Baidu stock normally trades around 25-times forward earnings. But even at a much more conservative 20-times forward multiple, you’re still looking at a four-year forward price target of $350 (20 multiple on $17.40 earnings).

If you discount that back by 10% per year, you arrive at a present value for BIDU stock of just under $240.

Bottom Line on Baidu Stock

Broad weakness in the big growth tech sector has created an opportunity in Baidu stock. At $220, Baidu stock looks undervalued considering its huge growth prospects through China’s secular growth digital advertising market.

Under conservative modeling assumptions, Baidu stock looks fairly valued around $240.

Thus, at $220, the risk-reward profile on Biadu stock looks compelling.

As of this writing, Luke Lango was long BIDU, FB, and GOOG. 

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