by David Eller, Investment U Research
Friday, December 21, 2012: Issue #1931
I don’t think I’m overreacting when I say that our stock market has been acting like a blender set on pulse.
The S&P closed near 1440, with five of the last six days seeing minor moves and the index not far off of the September high. Meanwhile, the fiscal cliff is still unresolved…
We don’t have a clear direction in either the short or the long term. And even worse, the direction is being controlled by politicians, as fiscal cliff sound bites act like the finger pressing the blender’s pulse button.
Why bother fighting this war?
The fact is, you don’t have to. There’s one place that seems to be rebounding nicely right now… China.
Government reported economic data has made a big turn, and investment dollars are flowing back into the country. But have you missed the boat?
The iShares China ETF (NYSE: FXI) is up 23% since the beginning of September, BUT many of the leading local technology companies haven’t seen the same gains.
Part of the reason is a complaint filed by the SEC against Chinese affiliates of the “Big Four” accounting firms. The SEC wants to see the detailed working papers of the Chinese auditors, which conflicts with a local secrecy act, and the companies are barred from providing this information. Investors have responded with a knee-jerk reaction that has pressured the shares. The concern is that the SEC will delist the shares. But for major Chinese companies active in the global economy, this isn’t a realistic outcome.
In the last 10 years, many Chinese companies have come public and are accessible on U.S. securities exchanges. But one company stands out as a potential investment for long-term investors: Baidu (Nasdaq: BIDU).
Baidu provides the Chinese version of Google’s search engine. After coming public in 2005, Baidu grew dramatically in 2009, and the share price increased 16 times from the 2009 low to the 2011 peak. Since that time, the share price has fallen back to Earth.
Part of the reason for the decline is competition from a new company, Qihoo 360 Technologies (NYSE: QIHU). Qihoo is a diverse software vendor with a browser that pointed searches to its own engine and away from Baidu’s. As Qihoo’s browser took market share, it pressured Baidu’s growth rate, and took the froth out of Baidu’s valuation.
Baidu is now trading at 16 times forward earnings and has been growing profits at 60%.
As we’ve mentioned before, forward earnings is a better metric to use than trailing, because we’re buying into what the company can produce in the coming years – rather than what it did last year.
The operating margin is 51%, showing that the business model allows it to convert more than $0.50 of every dollar into profit. This is a very high level, even for a technology company.
China’s recovery appears to be underway, and long-term investors can participate through local blue chips. Baidu is just one example. Just be sure to look for market-leading companies with real sales and earnings. In the case of Baidu , its search engine is focusing on the market with the largest number of consumers in the world, at a time when that region’s economy is strengthening. This is flowing through the financials to investors.