Technically, the problems for Baidu (NASDAQ:BIDU) stock started in May of 2019. It lost footing there and launched a bearish pattern with a potential 60% downside drop. BIDU stock almost filled the entire thing as it tumbled 50% thereafter.
It stopped just shy of the ideal crash target, and finally bottomed after the 2020 pandemic panic crash. From there the bulls enjoyed a 325% rally. Unfortunately it ended in tears starting February, as BIDU went on to fall 60% from the cusp.
Today we argue that it’s viable to hold BIDU stock long for the long term. While it is not the all clear, it is reasonably safe to wade back into these waters.
I’d like, however, to leave a lot of room for error and doubt. This last correction is not from anything wrong with Baidu. The Chinese authorities are waging war against their large-cap companies there. In their pursuit lies a rubble of excellent stocks in ruins like Alibaba (NYSE:BABA) for example.
They are leveling the playing field, so they are crimping profit potentials for all of them.
BIDU Stock Is Not the Problem
The iShares Trust – iShares China Large-Cap ETF (NYSEARCA:FXI) fell 30% before it also bottomed in late July. This is not the first time this has happened. The FXI also fell 30% twice, once in January of 2018 and again in April 2019. BIDU stock did not seesaw as much, but fell just as violently.
Its recovery from the 2020 bottom was healthy until December – too healthy perhaps. It was a rocket ride to $340 per share and unreasonable. Wall Street did its usual and overshot in both directions, so they priced it out almost as quickly.
For the last two weeks, BIDU has been trying to stabilize. The level at which it’s doing so makes sense, because $140 has been pivotal since 2019. When equities fall into significant breakout necklines, they tend to find support on the way down.
I don’t expect a reversion back to the highs, but the first step is to find footing. At this stage savvy investors could use options to deploy risk and leave room for error. There are no experts on Chinese politics, so we have no idea if they have achieved their goals. There could be more headline shocks to come.
Case in point this week stocks like Roblox (NYSE:RBLX) and Tencent (OCTMKTS:TCEHY) fell apart on headlines about “spiritual opium.” The government wants to limit game screen times for kids. There’s no amount of homework that can help us forecast such pitfalls. Therefore, all bullish positions on Baidu stock must carry the speculative label. This means that investors would do well not to go all in.
Caution Is Key
In such predicaments, instead of buying upside hope I prefer selling downside risk. This way I don’t even need a rally to win. A traditional investor has to risk $157 to buy shares, with no room for error. An options trader can instead collect a premium for selling a BIDU put 20% below current price.
This is also a bullish position, but it could still profit after a full-blown correction. Even then, I would temper my enthusiasm because of the overall macroeconomic conditions.
Last week, Federal Reserve Chair Jerome Powell all but committed to starting tapering this year. This is the first step in ending the QE that started in 2018. There is a possibility that equity prices will miss the biggest tailwinds they’ve had in decades if not ever. The indices at all time highs are could be vulnerable to sharp declines.
There are also geopolitical risks brewing in Europe, especially in Germany. We’ve had politicians all over the world create havoc on Wall Street before. It wouldn’t surprise me if the next crisis in stocks came from them. Regulators have pretty much plugged the potential financial system threats. But I don’t underestimate the political will to destroy in order to accomplish goals.
We don’t know what we don’t know, so there’s always room for surprise shock. The world doesn’t plan on having accidents, yet they do happen. Protecting portfolios is easy by using instruments like the CBOE volatility index (VIX). Keeping an entire equity portfolio long without that is hazardous at these altitudes.
Why Bother With Baidu?
Don’t get me wrong, the bulls are completely in charge of the price action, but I am cautious nonetheless. BIDU stock is in a viable recovery trade inside this bullish price action. The upside potential could be significant even if it just came back to the July neckline. That would account amount to a 30% recovery off the bottom. There will be sellers lurking there and also at $210 per share.
Since the company fundamentals are solid, it also makes for a good long-term investment. Total revenue is growing at a healthy clip, and net income more than doubled since 2017. Yet owners of the stock are realistic with their expectations. Baidu’s price-earnings-ratio is under 9, and its price-to-sales is only 3.
It will be difficult to disappoint investors who have humble forecasts. Owners of the stock down here are less likely to panic sell it. The simple conclusion is that Baidu’s upside potential outweighs the downside risk.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Nicolas Chahine is the managing director of SellSpreads.com.