Alibaba Stock Is Due For A Correction Now: Alibaba Group Holding Ltd (BABA)

  • Alibaba's short interest has risen by 60% since May.
  • BABA stock appears to be overvalued compared to its peers.
  • And data shows that China's e-commerce industry might slow down, all leading to a potential correction in Alibaba's stock.

Stockholders of Alibaba (NYSE:BABA) have had a great run this year. Shares of their company have appreciated in value by about 70% since mid-February, and about 40% over the past 12 months. So, with such a blazing rally behind it, I think it’s only fair to evaluate the sustainability of this uptrend. Will the rally continue? Or is Alibaba stock overvalued at this point in time? Let’s take a closer look at a few critically important metrics to have a better understanding of the matter.

Decelerating Chinese E-Commerce Market?

Let me start by saying that China’s e-commerce industry has grown to become an international unicorn over the past few quarters. When the entire Chinese economy was showing signs of a slowdown in recent times, the e-commerce industry was defying the overall macroeconomic trend and posting growth on a sustainable basis. This not only bolstered the country’s economy over the recent months but also catapulted the growth of companies operating in the domain. Investors loved the rapidly growing industry, and attached a market premium to Alibaba, as it was leading the country’s pack of e-commerce companies in terms of both, sales and sales growth.

Also Read: Alibaba (BABA) Stock Has A 26% Upside Potential Right Now

But this gravity-defying scenario won't necessarily last forever. There appears to be a divergence within the country’s e-commerce segment. Using the research data published by Analysys, I compiled the chart below, which clearly highlights that China's online apparel sales growth has declined to its 2-year low in the recent quarter. Granted that the sales volume is still high, it’s the second highest in past 10 quarters, but the fact of the matter is that online apparel sales growth has declined for two-quarters straight.

ECOMMERCE

Sure, this might be a one-time isolated event, but it could also be related to the overall health of China’s e-commerce industry. What if this is this is just the start, and a similar deceleration in growth rate happens in the country’s overall online sales over the next few months? There isn’t any data available to say anything otherwise, so this is clearly a valid risk-factor that Alibaba investors need to worry about.

Alibaba might be a great company, with highly efficient and profitable operations, but if the overall e-commerce industry starts to slow down, it would most certainly feel the negative effects of such an eventuality. After all, you can’t really expect a company to deliver sustainable blockbuster growth quarter after quarter, when the only way left to grow is at the expense of others' market share. Sooner or later, industry trends catch-up with companies and act as dampeners or propellants to their overall growth rate. With that said, let’s now take a look at the next part.

Stretched valuations

Let’s talk about valuations for a bit. After all it’s the valuation metrics that determine whether a security or a stock is overvalued, fairly valued or undervalued at the end of the day. If we’re going to talk about how expensive or cheap a stock is, we must also know the market rates for similar products available in the market. So, I compiled the valuations of JD.com, Ebay, Alibaba, Tencent and Baidu to have a better understanding of the current trend of valuations.

Valuation

The key thing to note here is that Alibaba’s valuation metrics are on the higher side in all of the five discussed ratios. So this indicates that there’s quite a bit of room for Alibaba’s valuation to normalize; BABA stock could correct by 15-20% to make it valued at par with the other aforementioned players. And the correction could be even more drastic if China’s e-commerce industry actually slows down, as feared, over the coming months.

The point that I’m trying to make is that there’s plenty of downside risk for Alibaba, should the industry or the company’s own growth rate came in below the projected forecasts.

Surging short interest

I also like to track short interest data of companies as it acts as a gauge for market sentiment. For starters, a sharp increase in a company’s short interest would generally highlight the fact that there has been a rapid accumulation of short positions and that market participants are betting on the stock to falter. Conversely, a drastic decline in the metric suggests that market participants no longer foresee a significant downside in the stock. So essentially the short interest metric provides us with a rough idea about whether the market is bearish or bullish on a stock.

Coming back to Alibaba, there has been a rapid accumulation of short positions in the stock. Its short interest has spiked to all-time highs, rising by about 60% since May, and 12% over the past month alone. This would suggest that market participants in general don’t think that Alibaba’s current stock price is sustainable and that they expect a significant correction in the stock's trading value.

Also Read: 3 Reasons Why Alibaba Stock Is A Good Buy Now

I would rule out the possibility of a short squeeze as only 12% of the company’s entire float stood shorted at the end of FINRA’s last reporting cycle. Plus, the days to cover all short positions as per the cycle’s average liquidity levels stood at a reasonable 6 days. But the fact that BABA stock has hovered in the same price-band over the entire past month corroborates my theory that market participants aren't as bullish as they were a few months ago. So that’s another key factor that Alibaba investors should keep an eye on.

Final thoughts

I’m of the opinion that Alibaba stock could correct over the next few months. Warning signs appear to be already there -- the stock is valued higher than its peers, there’s divergence within China’s e-commerce industry and short interest in the company is piling up with each passing month. So investors should exercise caution.

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Author's Disclosures & Disclaimers:
  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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