Personal Finance

Forget Sogou, Baidu Is a Better Chinese Tech Stock

Three young professionals look at a tablet.

Sogou (NYSE: SOGO) went public last November at $13 per share, but the stock now trades at about $6. A combination of decelerating sales growth, a flight from Chinese stocks in general, and a depreciating renminbi (RMB) crushed the company's initial investors -- and more pain could be on the way.

Sogou's year-over-year revenue growth slowed to just 7% during the third quarter , marking its slowest growth rate since its public debut, and net income tumbled 10%. The company expects its revenue to rise 5%-11% year over year during the fourth quarter, and analysts anticipate a 20% drop in earnings.

Three young professionals look at a tablet.

Image source: Getty Images.

Simply put, Sogou is a weak stock in an out-of-favor sector, and it's unlikely that it can rebound to its IPO price anytime soon. So instead of buying Sogou, investors should take a closer look at its bigger rival Baidu (NASDAQ: BIDU) .

David, meet Goliath

Sogou was originally Sohu 's (NASDAQ: SOHU) search engine division, but it remained a distant underdog to Baidu. Baidu currently controls 65% of China's online search market according to StatCounter, while Sogou ranks third with a 7% share. Alibaba 's Shenma ranks second with an 18% share.

Sohu tried to sell Sogou to privately-held Qihoo for $1.4 billion in 2013, but those talks fell apart. Tencent (NASDAQOTH: TCEHY) acquired a 36.5% stake in Sogou for $448 million later that year, and eventually boosted its position to 44% prior to the company's spin-off and IPO. Sohu retained a 38% stake in Sogou.

Tencent believed that integrating Sogou into its WeChat and QQ ecosystem would widen its moat against Baidu. That move likely saved Sogou from becoming obsolete, but the platform still reached far fewer users and advertisers than Baidu.

How badly is Baidu beating Sogou?

There are four key ways to gauge a search engine operator's success: its growth in advertising revenues, advertising customers, and ad revenue per customer, as well as its ability to control its traffic acquisition costs (TAC). Here's how Baidu and Sogou fared in those departments during their third quarters:

Baidu Sogou
Total ad revenue $3.27 billion $255 million
Total ad customers 522,000 81,000*
Ad revenue per customer $6,300 $2,600*
TAC YOY change 25% 58%
TAC as % of revenue 11% 49%

Source: Company quarterly reports. *Auction-based pay-for-click only. YOY = year over year.

The worst problem for Sogou is its surging TAC, which indicates that it's spending much more of its revenue than Baidu to attract traffic. Unfortunately, Baidu's 18% year-over-year growth in ad revenue still easily outpaced Sogou's 13% growth in search revenue.

Baidu also generates substantially more revenue per advertiser, and it grew its number of customers and revenue per customer sequentially and annually last quarter. Sogou, however, posted sequential declines in both categories.

More irons in the fire

Baidu generated 80% of its revenue from ads last quarter. The rest of its revenue came from its other businesses, including its stake in iQiyi and other smaller businesses.

Sogou generated 92% of its revenue from its search platform last quarter. The rest of its revenue comes from its "other" businesses -- which mainly consist of AI hardware devices like smart speakers, smartwatches, and translation devices.

Both Baidu and Sogou are expanding their ecosystems . Baidu's Alexa-like DuerOS reached 141 million devices in September, it's attracting high-profile partners for its Apollo driverless platform, and it's adding mini-programs to its core Baidu App to counter Tencent's mini-programs for WeChat.

A woman sits in a driverless car.

Image source: Getty Images.

Sogou's main expansion play is the Sogou Mobile Keyboard, an AI-powered mobile keyboard and voice search app that grew its daily active users (DAUs) 32% last quarter against the prior year to 405 million. Sogou claims that the app processes over 500 million voice queries per day. Sogou is trying to expand the app's reach into hardware devices through its hardware division, but it could struggle to compete against Baidu's growing list of DuerOS partners.

In sum, Baidu can leverage its position as China's top search engine to aggressively expand into adjacent markets. Sogou simply can't match that market clout, even with the support of Tencent's WeChat and QQ platforms.

Better growth and lower valuations

Analysts expect Sogou's revenue to rise 26% this year, but that its earnings will tumble 21%. Baidu's revenue and earnings are expected to rise 20% and 5%, respectively. Sogou's stock trades at 27 times this year's earnings, while Baidu trades at just 20 times this year's earnings.

Therefore, the choice between Baidu and Sogou is clear. Baidu's "best in breed" reputation in China's online search market should help it rebound as Chinese stocks recover, but Sogou could be left in the dust.

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Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Baidu and Tencent Holdings. The Motley Fool recommends iQiyi and The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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