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Shouldn't the Google of China Be Growing Faster Than Google?

Baidu (BIDU) has made great fortunes for shareholders as China’s biggest Internet search company, and no one doubts that it will grow greatly in years to come. But the investment community looks confounded over the value of Baidu stock. Just how much should investors pay for shares in the Google (GOOG) of China, a place where millions of people are just beginning to get online?

Recent analyst comment on the shares has included two reiterated buy/overweight ratings and two sell recommendations. Two others downgraded the shares to holds. Most of the commentary followed Baidu’s full-year earnings and forecasts released Feb. 4, which included 54% revenue growth and 46% operating profit growth that pretty much met forecasts. But its outlook led analysts to predict about 36% revenue growth and 13% EPS growth this year, and the market was looking for more, as seen in a stock chart.

BIDU Chart

BIDU data by YCharts

Baidu is the second largest Internet search company on earth, controlling about 79% of the market in China. (Google all but left China in 2010 over censorship and hacking issues.) Concerns over a Baidu investment now arise from growing competition, especially Qihoo 360 Technology (QIHU), a company with a popular browser that just jumped into search.

The fight between the two companies is bound to intensify. Qihoo and its trash-talking CEO have been widely criticized for unfair competition, like allegedly using software that trick people into searching on Qihoo instead of Baidu. Apple (AAPL) removed Qihoo apps from iTunes, and the company has been warned by Chinese authorities, but it still gained a 10% market share of Chinese search in the few months since it got into the business late last year. It’s the sort of nastiness that can make U.S. investors nervous about investing in Chinese companies, yet Qihoo is clearly winning investor sentiment at the moment. Qihoo shares have nearly doubled in the past six months; Baidu is down 27%.

Baidu is spending a lot of money on technology aimed at keeping the competition at bay. That, along with the fact that mobile searches bring in less money, has put pressure on very strong profit margins that have attracted investors to Baidu shares for years. The margin narrowing alarmed investors. Its forward PE ratio at 20.11 just dropped below Google’s.

BIDU Forward PE Chart

BIDU Forward PE data by YCharts

Baidu skeptics are waiting to see whether its recent profit margin slide is temporary or the new reality for a company that may lose market share amid strong competition. The bulls on the stock see Internet search exploding in China as more and more of the population gets online, and plenty of business to go around.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.

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