Is Alibaba Stock A Buy At The Current Valuation?

  • Why is Alibaba stock moving pretty much sideways since its IPO?
  • What’s the problem with current valuations and what are the long-term implications?
  • Is the world’s biggest marketplace company a buy even at this price point?

Chinese retail giant Alibaba (NYSE:BABA) is possibly the most profitable e-commerce company in the world. Their marketplace model, where the company just connects the buyers to sellers instead of the buying its own goods to sell, has worked wonders for the company’s bottom line.

And to top that off the company doesn’t even directly handles shipping of its products, but instead prefers to be a mere supervisor in the shipping process, making sure that deliveries are moving along smoothly. The marketplace model coupled with the hands off approach to shipping has allowed the company to consistently record above 25% operating margins. In the retail world, less than 5% margin is the norm, but Alibaba has turned the whole concept on its head. In fact it wouldn't be stretch to call the company an e-commerce facilitator instead of an e-commerce retailer.

Also Read: A Huge Upside Potential Makes Alibaba Stock A Strong Buy

The Valuation Issue

Alibaba went public in September 2014 but after a brief pop, the stock has edged lower and lower even as revenues nearly doubled from CNY 52.504 billion in 2014 to CNY 101.143 billion in 2016. The stellar growth numbers barely had an impact on the stock price, which has just breached the $93 level that the company reached at the end of its first trading day.

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The biggest problem was that Alibaba’s valuation was way over the top at the time of its IPO launch, selling for nearly 18 times sales. Thanks to the revenue growth Alibaba’s stock is now trading at 14.7 times sales, which is way over the top as Amazon (NSDQ:AMZN), the e-retail king of every country except China, is trading at a mere 3.1 times its sales.

The P/S Disparity with Amazon

The only key difference between the two companies is their rate of growth. Alibaba has been doubling its revenue every two years while Amazon is doubling its revenue every three years. But does that warrant a near 5 times difference in price to sale ratio between the two companies?

Alibaba is still a one country company, relying on China for all its sales and hardly any presence outside the country. Amazon, on the other hand, already has robust operations all over the world, and the company is already the number one player in the Indian market. That means Amazon has a better runway for growth in the next 20 years than Alibaba, which is yet to prove its mettle in a single market outside its home country.

Since we all know the way the Chinese arm-twist international companies to serve their own end, it’s not hard to imagine that many countries are definitely going to return the favor to big name Chinese companies when they land on their shores. The negative sentiment in other countries about Chinese company will also be a critical factor to consider. How this plays out one can only guess, and the reason that Alibaba has not yet thought of entering a single developed market till date despite having a successful platform for more than ten years clearly indicates the apprehension on Alibaba’s part about getting out of China.

Besides, being a marketplace operator, Alibaba doesn’t have any kind of moat that would help them dominate the space in any market outside China. Their model is easily replicable because they neither own the products nor any part of the shipping network.

How Will Their Valuation be Affected Long-term?

In fiscal 2016, Alibaba had nearly $15 billion in revenue and the company is valued at $243 billion at the time of writing this article, so the stock is selling at almost 15 times sales, way over the top when compared to Amazon. Alibaba’s continuous growth numbers have immensely helped, but the valuation will have to correct itself at some point, which means there is not much upside for an investor in the long term.

Let us assume that Alibaba takes another eight to ten years to reach $107 billion in sales - the number that Amazon recorded for last fiscal. Let’s also assume that at that point the price to sales valuation adjusts to Amazon’s current level of 3 times its sales. That means Alibaba’s market cap will hit $321 billion at that point. Alibaba is already at a market cap level of $243 billion right now, so that will be a 32% increase in the next eight years, or a CAGR of around 4%.

As sales increase, the valuation has to correct downwards, and it leaves very little room for investors to get any returns. However, there is still plenty of room within the China market itself, which is the reason why the stock is staying at the current levels. That cannot go on forever and Alibaba stock can, at best, show sideways and slow upward movement from here. It's a great business but at a ridiculous price.

It’s still a good company with a solid business model, but that doesn't mean that the price is right. At the current price point the company hardly leaves any margin of safety. If you want to buy a piece of this Chinese business, then add slowly into your position over a long period of time, adding whenever the stock gets hit either with an earnings miss or due to some bad news, which I am sure we will have plenty of over the next ten years. If you want short to medium term gains, look elsewhere.

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  • I do not have any business relationship with the companies mentioned in this post.
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