Baidu Inc. (NASDAQ: BIDU) counts among the best foreign stocks Americans can own. The Chinese search engine remains a proxy for the phenomenal growth of the Internet in the People’s Republic, on both personal computers and portable devices. Sales and profits continue to ramp up with impressive speed. But Baidu shares have dropped to near a 52-week low. Baidu has turned out not be to a good investment at all.

Baidu’s stock currently trades below $110, against a 52-week high of $154.15 and a low of $99.71. Over the past year, Baidu’s shares are off more than 20%. U.S.-based search company Google Inc.’s (NASDAQ: GOOG) stock is 30% higher over the same period. Google is supposed to be trapped in relatively mature markets, which include America and Western Europe. It is mostly frozen out of the large Russian, Chinese and Indian markets by local competition. In addition, Google’s Android OS does not make much money and could face patent challenges from Apple Inc. (NASDAQ: AAPL).

Baidu has as much as 80% of the Chinese search market. Some analysts claim that its share is protected by the Chinese government, which has made it difficult for Google to operate in the nation. Why let an American company that believes in freedom of speech pick up a large part of the market? Baidu’s revenue and operating profit improvement have been extraordinary. Revenue rose 60% in the second quarter to $859 million. Operating profits rose 52% to $443 million.

The markets have realized that Baidu’s business and market valuation face a number of stiff challenges. Even with the drop in its share price, the company has a market cap of $38 billion, against what is likely to be only $4 billion in revenue this year.

But Baidu’s problems run deeper than earnings. Investors have begun to ask why it is so small compared to the size and rapid growth of the Internet markets in China. If China’s Internet-enabled population is so large, why is Baidu relatively so small? That question may have several answers.

The first is that the government in the People’s Republic watches online activity carefully. Few activities are as revealing as what people search for. Baidu’s progress may be held back by the actions of the government in its home market.

Next, Baidu claims it can diversify into other markets. Japan was supposed to the first of these. So far there is little evidence of success. The Baidu search technology may not be as portable as Google’s, and Baidu does not have the capital to make necessary investments to expand beyond China.

Finally, it is naive to say that the Chinese use the Internet the same way that people in America and Europe do. Search may not hold the promise in the Asian nation that it does elsewhere, if search adoption is relatively poor.

Investors have taken a closer and closer look at Baidu’s prospects, and they are not as good as they appeared a year or so ago.

Douglas A. McIntyre

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