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By Matthew Coffina, CFA and Dan Su, CFA | 05-23-2013 12:00 PM

Tapping Growth, Minding Risks in China

Chinese Internet giant Baidu offers robust growth at an attractive share price for investors who can get comfortable with the regional and business-specific risks, say Morningstar's Matt Coffina and Dan Su.

Securities mentioned in this video
GOOGL Alphabet Inc
BIDU Baidu Inc

Matt Coffina: For Morningstar StockInvestor, I'm Matt Coffina.

I'm joined today by Dan Su, who is a senior equity analyst on our consumer team, and we're going to talk about the risks and opportunities of investing in China.

The company that I'm particularly interested in is Baidu, which we own in StockInvestor's real-money Hare portfolio.

Dan, thanks for joining me.

Dan Su: Thanks for having me, Matt.

Coffina: Maybe you could first just lay out the investment case for Baidu. Why has this company grown so quickly historically? Why you expect it to continue growing? And why you think it's cheap right now?

Su: So the growth story of Baidu is actually pretty straightforward. It has a strong search product, as well as a number of other online services that really cater to the relatively young entertainment-seeking Internet crowd in China. So Baidu has built itself into a major traffic hub for Internet users over the past 10 years, and basically monetized its popularity through search advertising along the way. Obviously, I'd mention that the explosive growth in the Internet population in China also helped Baidu.

Looking forward, I see a couple of secular tailwinds that should continue to benefit Baidu. Number one, the ad spend will continue to grow as the economy grows, and the ad budget is increasingly shifting to the online channels from offline--especially to search advertising, given the attractive marketing ROI. Baidu only serves about 2% of the small-business owners in China today, so we see plenty of growth opportunities ahead for the company.

The stock has been under pressure a little bit in the recent couple of months, given investor concerns about the mobile Internet. We agree that mobile monetization for Baidu is probably at an early stage, but we think investors have underestimated the strategic investments that Baidu has made in the recent three to four quarters in terms of Mobile Map, in terms of voice search, cloud computing, and content inventories for consumption on the mobile Internet that, in our view, has positioned the company really well for longer-term growth opportunities on the mobile Internet space.

The stock is cheap, trading at a 25% discount to our fair value estimate, which is at $125, and is trading at 16 times forward earnings, which we view as an attractive valuation for a quality growth story like Baidu.

Coffina: So there are risks that come with investing in emerging markets, and China in particular. Could you just highlight a few of those that U.S. investors might be less familiar with?

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