Is Alibaba Stock a Purchase?
Investors often drool over the benefits of Chinese companies operating in the world’s most populous country and the second richest economy. E-commerce company Ali Baba (NYSE: BABA) dominates China, claiming 15% of the entire world population as customers. But China’s political risks can impact businesses, making Alibaba a red-flag minefield for investors to navigate.
The company’s stock price has fallen almost 40% in the past year. Is Alibaba worth buying on the downside? Here are three key things to consider before making that decision.
1. Alibaba has been expensive stock for years
The history of a stock’s price may make investors think that a stock is expensive or cheap. In other words, “the stock is down 30% this year, it must be the right time to buy. This can easily turn out to be wrong, as there are many reasons why a stock price can fluctuate.
Compare Alibaba with Amazon (NASDAQ: AMZN), a peer with a similar economic model (e-commerce and cloud services) and a parallel leadership position in massive markets. Amazon stocks are trading at a price-to-sell (P / S) ratio of between low and mid numbers since the dot-com bubble burst almost 20 years ago.
Alibaba started trading on US stock exchanges in late 2014 and had a P / S ratio of over 24 in early 2015. Could you argue that Alibaba deserved a premium over Amazon? Of course, its revenue has grown an average of 48% per year over the past five years, compared to Amazon’s 29%.
But I don’t think it’s easy to justify a valuation several times higher than Amazon. If you follow Alibaba’s P / S ratio since 2015, you will see that it is well on its way to the downside. The drop in Alibaba shares is not necessarily a fluke that investors should rush to buy; its valuation followed a downward trend over several years because the stock was overvalued.
2. Political pressures complicate the assessment
Alibaba has been caught in political turmoil over the past year. Alibaba founder Jack Ma criticized Chinese banking regulations; make controversial comments about China’s financial system, which is heavily state-controlled, saying it lacks innovation and has an outdated risk mindset. The comments came shortly before Ant Group, another company founded by Ma and owner of China’s largest digital payments platform (Alipay), went public. Alibaba owns a third of the company’s capital.
Chinese regulators have blocked Ant Group’s planned initial public offering, citing potential risks to the Chinese financial system, and it may now be forced to dismantle its Alipay platform and hand over user data to an owned entity. partly by the Chinese state. Oddly enough, Ma has been out of the public spotlight for months after Ant Group’s IPO was blocked.
Investors should understand that the Chinese government is heavily involved in its affairs and has the power to interfere in the operations of companies.
Separately, China has pressured large Chinese tech companies with its “common prosperity” program to resolve economic inequalities by redistributing wealth across the country. Chinese President Xi Jinping stressed the need to increase the incomes of the poor and the middle class, while “adjusting” excess wealth.
China’s largest companies, including Alibaba, have pledged to support these efforts. In Alibaba’s case, the company is donating 100 billion yuan by 2025, the equivalent of $ 15.5 billion. Alibaba’s profits for the full 2021 fiscal year were $ 21.8 billion, so that amount could lead investors to think this move is too important to be purely voluntary.
These politically sensitive events create problems for investors. It is difficult to predict when, or to what extent, a Chinese company might have contact with its governing state. Events that have already happened also make it difficult to trust what is being said in the future.
3. What potential do we see?
Finally, investors need to consider the upside potential if things work over the long term. Alibaba already has a market capitalization of $ 435 billion. Amazon has a market cap of $ 1.7 trillion, but generates around four times the revenue. Based on their current P / S ratios, their valuation is fairly even.
Alibaba would need to grow organically to boost its share price, as it’s hard to justify a premium on Amazon in light of all the political noise. Analysts expect Alibaba to increase revenue by 20% in 2022, so it could take years to see a significant appreciation in the share price if political questions remain.
Consider the opportunity cost for your money
Meanwhile, the stock market is a vast ocean of strong and emerging companies. Maybe Alibaba can put an end to its political questions. Perhaps the stock can regain a higher valuation after a downtrend for several years. Perhaps Alibaba will continue to grow fast enough to generate strong returns for investors.
But I’m not sure that a $ 435 billion company has enough benefits to justify all of those “maybe”. Investors might be better off looking at smaller, faster growing companies that don’t carry Alibaba’s political baggage. Inventories in the Creator Economy, including Fifth, Pinterest, and Etsy could be great places to start.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.