Is Baidu a Buy During This Chinese Selloff?

Image: Baidu.com

Chinese Internet search giantBaidu has been dragged lower and lower over the past couple of months along with the entire Chinese stock market, which continues to tumble. However, Baidu seems to be getting hammered just for its association with China, regardless of the fact that the company itself trades in the U.S and other than slightly lower-than-expected EPS last quarter, it's performing quite well.

Now that shares of Baidu are nearing a two-year low of around $145, the stock is trading at an incredibly low forward-looking 2016 P/E of just 3. Baidu looks like a great value play with long-term growth potential.

Baidu and China's stock market plunge

The Shanghai Composite Index rose 150% in the 12 months from June 2014 to June 2015. The market was flooded with new entrants trying to get in on the growth, and more than 40 million new stock accounts were opened in China during that year. Of course, this rush led to incredibly high valuations without the foundation to keep those gains stable. Over the summer, the bottom fell out of this extremely overpriced market, and it has lost about half of its value since June.

The stock market in China is a mess, to say the least, but Baidu has few ties to the Chinese stock market, as it trades as an ADR on the NASDAQ and not on the Shanghai Stock Exchange. It went public in 2005. Baidu is tied to China's economy, of course, and could be affected by this market crash, but here's why that fear looks to be overblown as well.

What about China's slowing economy?

"But its not just the market," you say. "The economy is slowing, too." That's true. The Chinese economy is projected to grow just 7% this year. Yet while 7% is far lower than the double-digit GDPgrowth in the early 2000s, it's still enough to make China's one of the fastest-growing economies in the world.

There are concerns that the Chinese government is overstating growth with the 7% figure and that the real growth rate is significantly lower, but GDP growth is not the number Baidu investors should be interested in. Instead, look at the growing number of Chinese citizens entering the middle class there and becoming Baidu's target market, and you'll see just how massive the opportunity in China still is.

Baidus core product is web search. Its wide array of products include products based on user-generated content, social-networking products, security products, and online marketing products. It also operates a Japanese search engine. It's recently been making news for its push into online-to-offline (O2O) services.

Baidu's opportunities for growthThere are already 650 million Internet users in China, roughly double the size of the entire U.S. population. However the Internet penetration rate in China is still just just 46%, compared with nearly 90% in the United States. Even a 10% higher Internet penetration rate in China would mean about 140 million new potential customers for Baidu.

ANZ Greater China economists Li-Gang Liu and Louis Lam reported in May that they project 326 million people will move into the middle class in China by 2030.As China's citizens continue to move into the middle class and have access to computers and smartphones, the number of potential Baidu customers with Internet access will continue to increase by the millions each year. http://uk.businessinsider.com/chinas-rising-middle-class-will-create-opportunities-the-world-has-never-seen-before-2015-5#ixzz3kbovukxb

SinceGoogle leftChina in 2010, Baidu has been nearly unchallenged as the main search service, and now it has around a 70% market share in China, with offerings similar to those of Google, including search, advertising, and a host of digital services such as video streaming.

Other than a growing user base, Baidu also has a long-term opportunity in its moon-shot ideas, just like Google. Baidu is working on its own "connected" car, and some reports say Baidu has teamed up with DaimlerandBMW and could even have a driverless car to market before Google. Baidu also recently releasedan online health portal that serves as a patient-doctor booking tool. These kinds of long-term new business initiatives are investments that could lead to more major growth in the future if one or more of them take off.

Is Baidu a buy now?Baidu does face risks during this Chinese sell-off. For one thing, even though the company trades in the U.S., it's still a company mainly serving the Chinese market, and a recession in China would hurt its short-term sales. In addition, herd-investment mentality could continue pushing shares lower on fears of a Chinese market crash. Finally, because Baidu makes its money in Chinese yuan but lists revenue in U.S. dollars, the recent government-implemented yuan devaluation will slightly lower Baidu's earnings in the next release.

Still, Baidu's valuation is incredibly cheap right now. Its current P/E of 24 looks a little high, but consider that it's expected that 2016 year-end earnings estimates put the forward-looking 2016 P/E at an incredible ratio of just 3. Baidu's growing Chinese Internet search market, big new initiatives such as its healthcare booking service, and its relatively minimal ties to the Chinese stock market meltdown all look like very attractive reasons to bet on Baidu at these low prices.

The article Is Baidu a Buy During This Chinese Selloff? originally appeared on Fool.com.

Bradley Seth McNew has no position in any stocks mentioned. The Motley Fool owns and recommends Baidu, Google (A and C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.