Baidu’s wild rollercoaster ride

Investor’s in Baidu.com, Inc. (BIDU) have been taken on wild ride since the stock debuted in early August, 2005. In the little over a year since Baidu launched its IPO, the stock has seen a high of over $120, a drop to mid $40’s and a recovery to current levels over $90. I’ve written in 2005 that Baidu was severely overvalued, especially with the company’s lack of earnings and operating history. Baidu’s outstanding recovery from mid $40’s levels begs a re-analysis of the stock.

Raw Greed readers know that I am currently traveling within China. I have asked a variety of individuals in China which search engine was their choice for finding information on the Internet. The overwhelming response was Baidu. Market share statistics seem to confirm the word on the street that Baidu is the current leader in China’s search engine market. This Forbes article quotes a Xinhua news agency figure pegging Baidu’s market share at 62.1% as of September 19th, 2006.

Baidu has seen net earnings jump 9.38x from $1.45 million in 2004 to just under $15.46 million for the 12-month period prior to the company’s most recent June 30th, 2006 quarter. Baidu has an approximate market cap of $3 Billion and an approximate Trailing P/E of 192.

Comparing Baidu to industry leaders in the search engine and online advertising market, Google, Inc. (GOOG) and Yahoo! Inc. (YHOO) paints a different picture from looking at Baidu’s impressive earnings growth. Google’s net income was $2.07 billion for the 12-month period prior to the company’s most recent June 30th, 2006 quarter. Google has an approximate market cap of $123 Billion and an approximate Trailing P/E of 59. Yahoo!’s net income was $1.26 billion for the 12-month period prior to the company’s most recent June 30th, 2006 quarter. Yahoo! has an approximate market cap of $35 Billion and an approximate Trailing P/E of 30. Using the Trailing P/E of Google, Baidu should have an approximate market cap of $912 million. Using the Trailing P/E of Yahoo!, Baidu should have an approximate market cap of $464 million.

Baidu’s primary target audience is in a different geographic region with a very different opportunity for growth. A huge speculative risk premium has been attached to Baidu’s opportunity to capture the search attention of China’s future population of Internet users. Current prices for Baidu have pegged Investor’s as believing the risk premium is worth an approximate Trailing P/E of 192.

China is definitely an emerging economy with tremendous potential for growth. Comparing Baidu to Google and Yahoo may give investor’s an idea for Baidu’s potential performance in a well developed economy. This Market Watch statistic pegs Google’s market share of the U.S. search market at approximately 44%. If you were to double Google’s market share to 88% and likewise double Google’s Trailing P/E to 118 it would still be far less than Baidu’s current Trailing P/E of 192.

China has a long way to go in developing its Internet user base, censorship and usage policies. I believe the speculative premium attached to Baidu has gone out of hand for a company lacking a lengthy earnings history. If the global economy takes a turn for the worse and the markets sour, I expect that the stock prices of speculative companies like Baidu will be the first to experience a severe downturn.

If Baidu rises above $100 I may take a short position in the stock. A short position in Baidu may make a good hedge against a slowing Chinese economy and sluggish stock market.

*Disclaimer, the author does not own any shares in any of the companies mentioned above.

Microsoft’s Zune vs. Apple’s brand building

There has been a lot of clamor about Microsoft Corporation’s (MSFT) new Zune device. Zune is portable audio and video jukebox similar to Apple Computer Inc.’s (AAPL) video iPod. The devices have a similar form factor and both work with files downloaded from their respective proprietary a/v distribution platforms and non-DRM files. There are some key technical differences between Microsoft’s offering from Apple’s, including a larger 4 inch screen and built in Wifi.

I believe Microsoft’s entry into the portable A/V jukebox world is a case of too little, too late. Microsoft dominates in the Operating System world and it appears the company believes it can dominate a category from sheer technical innovation. Portable A/V players are now a commodity and there is nothing exciting about the launch of a new device, even from a company the size of Microsoft. The market has been saturated with players that offered technical innovation from other features such as form factor, battery life or file compatibility. None of these portable A/V players have the mass-market appeal of Apple’s iPod and video iPod.

Apple’s effort in building a brand name and a loyal following behind the iPod is what differentiates its offering from other portable A/V devices. When the iPod was first released it was a must be seen type of device. There was a special aura about owning an iPod and being a part of a group of owners that were more hip to Apple’s offering. Apple’s marketing machine built a campaign from the stylishness and personalized lifestyle aspects of owning an iPod. When Apple began offering engraving services on the back of the silver clad iPod’s, the company had definitely hit upon mass market acceptance of the device.

Microsoft should take a page out of companies like Apple and work on building a brand name and loyal following instead of concentrating on technical innovation as the key driving factor behind a product launch. While I believe Microsoft has its share of rabid fans behind the Window OS, my opinion is that it’s rare for me to find a fan of Microsoft’s products across the board. If you compare an Apple fan to a Microsoft fan, I believe the Apple fan will be more likely to buy only Apple products. This is more likely due to Apple’s brand building efforts.

Microsoft has aggressively branched into different product categories over the past decade. The company has launched a tablet PC platform, the MSN search engine, and the XBOX interactive gaming platform. These products are among some of Microsoft’s more technically innovative products and have enjoyed only mixed success. Microsoft’s most recent Zune launch shows a corporate culture all too willing to bet that technical innovation is all that is needed to win a product category.

Microsoft could do well to learn from Starbucks, (SBUX). Coffee on a retail level was well on its way to becoming a low cost commodity a decade ago. Today if you walk around any major city in the States you should be able to find a Starbucks every few blocks with patrons happy to pay $2.00 and up for a cup of Java. There are more expensive and arguably better retail coffee brewers, but none have had the success Starbucks has enjoyed for the same reasons none of the portable A/V vendors have enjoyed the success of Apple. Customers happily pay for a brand name and consistent quality.

In the case of Zune, had Microsoft done more to promote its brand name outside of OS development I believe the company would have a much better chance of competing with Apple. For now Zune will likely get lost in the shadow of Apple’s well built brand name and consistent quality behind its iPod line of portable A/V players. I believe Zune will add little to Microsoft’s existing revenue’s. I expect that future medium-term, 1-3 year growth for the company will be hedged on the success of the Windows Vista OS.

*Disclaimer: I do not own any shares of any of the companies mentioned above.

Tanzanian Royalty Exploration Corporation and gold mining stocks update

After writing this article, I have followed through with my strategy in accumulating shares of Tanzanian Royalty Exploration Corporation (TRE).

On September 12th, 2006, I purchased 2000 shares of TRE at $5.09. On September 15th, 2006, I purchased 4000 shares of TRE at $4.45. I currently own 10,000 shares of TRE purchased at an average price of $5.74.

I am looking at purchasing shares of Yamana Gold, Inc. (AUY) at under $9. TRE and AUY are currently my top two gold mining stock picks.

I am considering purchasing shares of Northgate Minerals Corporation (NXG) at under $3 and Coeur d’Alene Mines Corporation (CDE) at under $4.40.

Uncovering Gold Mining Gems

Finding the next gold mining gem is a daunting task. I often have to use different screening criteria to come up with interesting stock picks just to begin my analysis. Today I will be using Joel Greenblatt’s investing formula for uncovering potential gold mining gems. For those of you unfamiliar with Joel’s formula, he uses only two main criteria for determining the attractiveness of a stock investment. These two criteria are Return on Capital and Earnings Yield.

Return on Capital (ROC) is measured by taking a company’s pre-tax operating earnings (EBIT) and dividing it by tangible capital employed, the higher the ratio the better. Joel uses ROC instead of the more commonly used Return on Equity (ROE = earnings/equity) or Return on Assets (ROA = earnings/assets) because ROC uses earnings before interest and taxes. Joel’s reasoning is that different companies operate with different levels of debt and differing tax rates. Both ROE and ROA can be found on Yahoo Finance by clicking the Key Statistics link under the company heading for any stock. Here is an example with Frontier Oil Corporation (FTO).

Earnings Yield is measured by taking a company’s pre-tax operating earnings (EBIT) and dividing it by Enterprise Value (Market Value of equity + Net Interest Bearing Debt). Joel uses Earnings Yield instead of the more commonly used Price/Earnings (P/E) ratio or Earnings/Price (E/P) ratio because P/E and E/P are greatly influenced by debt levels and tax rates while Earnings Yield is not.

In layman’s terms ROC helps you measure how much income a business is earning in relationship to how much it costs. A business with a high ROC means it can invest its own money into the business with a high rate of return. Earnings Yield helps you find a company that earns more compared to price you are paying for it.

Using Joel’s two criteria I screened for companies with a minimum market capitalization of $500 Million, a high ROC and a high Earnings Yield. Looking at the top 100 companies that met this criteria, I found one lone gold mining stock, Northgate Minerals Corporation (NGX). Northgate’s ROC is in the 25-50% range and the Earnings Yield is 17%. Northgate appears to be worth serious consideration and may be the next gold mining gem using Joel’s criteria.

Joel Greenblatt is the author of The Little Book that Beats the Market. In the book he discusses in detail, the advantages and strategies of using ROC and Earnings Yield to evaluate a stock investment. I highly recommended reading the book as it offers a simple and well reasoned approach to finding potentially undervalued investments.

Raw Greed’s profitable strategy review

I wrote this article on July 17th, 2006 about a profitable strategy in the market.

Here is a quote from the article:

I would play this short-term strategy:

1. Buy gold mining stocks in the next 1-2 weeks if gold trades above $700. This would signal a positive psychological entrenchment in mind of investors that the Middle East conflicts aren’t going to blow over anytime soon. I am actually giving readers a conservative approach. I have already started accumulating a gold position. My top two picks Yamana Gold, Inc. (AUY) and Tanzanian Royalty Exploration Corp. (TRE) now represent 1/2 of my portfolio.

2. Sell gold and take your profits as the Middle East conflicts ease and crude oil prices drop.

3. Buy (UMC) and other beaten-down tech stocks like my number 2 choice, eBay, Inc. (EBAY).

I did not execute step 2 properly since I have been concentrating on other projects. I should have been paying more attention to the news and prices of commodites and metals. For those of you who have been following my strategies I hope that you were able to handsomely profit by selling gold in the last month. If you are now holding UMC, EBAY or other tech-stocks, I would hold onto them as I expect to see a fall rally in technology issues. If you are holding cash, I would recommend watching how the commodities and metals market pans out in the next 2 weeks. I am looking for gold to stabilize at under $570.

Disclaimer: I currently own 4000 shares of TRE, purchased at an average price of $7.36 and 10102 shares of UMC purchased at an average price of $3.17.

Congratulations to David Jackson and Seeking Alpha

David Jackson e-mailed me to let me know about a successful partnership that Seeking Alpha has struck with Yahoo Finance. As Raw Greed readers know, I am a big fan of the service that David has created for bloggers like myself. Seeking Alpha’s most recent partnership with Yahoo Finance gives additional incentive for bloggers and members of the Seeking Alpha network to dedicate more time to writing articles and posting commentary. As a result of this partnership, I have renewed interest in more frequently updating Raw Greed.

My first order of action will be to update my portfolio which is currently trading at $147, 204.09.

Gold’s downward spiral

Gold appears to be headed down along with the price of crude oil. Historically there has been a correlation between the price of crude oil and gold. Most gold fans and economic historians peg the ratio between the price of gold to oil at 10:1. The price of crude oil is currently $65.71 per barrel. Using the 10:1 ratio would mean that gold should be priced at $657.10 per ounce. Gold is currently trading at $590.40. Gold has not been following the historical ratio as geo-political pressures and concerns over terrorism have contributed to a risk premium in the price of crude. If the historical ratio between oil and gold is to return, either gold has to rise or crude has to drop. I am more inclined to believe that gold will rise. Physical demand for gold tends to be strong going into the fall.

Some gold commentators believe that the drop in gold and crude is a concerted political effort to improve economic conditions before the elections. Here is a quote from a Kitco article by Doug Hornig:

That’s what Bill Murphy, of LemetropoleCafé.com believes, as he writes that, “One of my fears was, because of the desperation of those in power in Washington ahead of the coming elections, that they might bomb gold. It seems that was the plan. Now we need the physical market to hold the fort, which is likely to happen.”

In other words, it looks as though there may be a concerted attempt to push down the price of both gold and crude in the last two months leading up to the election, but considering the physical demand that normally comes on strong in the fall, that may be difficult with regard to the metal. And attempts at bottling up demand have a way of backfiring in dramatic fashion.

In these uncertain times, there will be wild swings in the price of commodities and metals. If another Lebanon conflict occurs or there is a future terrorist attack we will likely see the price of crude and gold reaching for new high’s once again. One of my two top gold picks, Tanzanian Royalty Exploration Corp., (TRE) has seen a dramatic drop in price following gold’s recent decline. I intend to load up on TRE if the stock drops below $5. I am monitoring my other top gold pick, Yamana Gold, Inc., (AUY) and I would like to build a position in AUY from $8.50-$9.

Disclaimer: I currently own 4000 shares of TRE, purchased at an average price of $7.36.