It still amazes me that few investors actually understand how Alibaba Group Holding Ltd (NYSE:BABA) makes money. And that lack of insight suggests that BABA stock — despite already outperforming the market — remains considerably undervalued. For reasons I will discuss, Alibaba stock has a clear shot to reach $120, netting new all-time highs.
When you mention retail and e-commerce, the name Amazon.com, Inc. (NASDAQ:AMZN) immediately comes to mind. And while BABA is often referred to as “China’s Amazon,” both companies — though they share some similarities — also have glaring differences.
Notably, unlike Amazon, Alibaba doesn’t store much of what it sells. Instead, BABA’s main business model, as its “marketplace” suggests, involves facilitating business transactions. Its main goal is to bring consumers together with millions of small producers and retailers around the world.
How Alibaba Stock Sets Itself Apart
Essentially, Alibaba stock is closer to, say, eBay Inc (NASDAQ:EBAY) than Amazon. Yet, investors continue to make the mistake of worrying about the BABA’s profit margins as if they were significant. That is not to suggest that Alibaba’s financials and cash flows aren’t important, but to the extent that profits margins should determine the direction of BABA stock, it doesn’t make sense. At least not until billionaire chairman Jack Ma makes margins, which have been all over the map, a key focus.
What’s more important to focus on is the manner in which users/consumers are embracing the marketplace and the rate at which new small businesses are joining the company’s market place. Specifically, Alibaba stock investors should ask whether can the company continue to generate record revenues and how well can it diversify the business into fast-growing areas such as the cloud? Keep in mind that this is an area where Amazon and Microsoft Corporation (NASDAQ:MSFT), hold the No.1 and No.2 spots in market share, respectively.
But BABA is on it’s way to joining the club.
Alibaba’s cloud platform Alicloud, which posted a 115% year-over-year jump in revenue, has become a force to be reckoned with. In the most-recent quarter, Alibaba posted a 54% jump in quarterly revenue, driven by the company’s cloud momentum, which surged to RMB 1.76 billion ($254 million). Not only are BABA’s paying customers growing at an impressive rate, but the company is also finding ways to get customers to pay more.
Bottom Line for BABA Stock
Analysts have yet to take Alicloud seriously, given that it accounts for only about 5% of Alibaba’s total revenue, but with the company looking to expand Alicloud beyond China, revenue growth will accelerate. And from a valuation perspective, BABA stock is priced at just 23 times fiscal 2018 estimates of $4.29 per share, which calls for YOY earnings growth of 23%.
When applying a reasonable price-to-earnings ratio of 28 to those estimates, I arrive at $120. And that valuation would still be almost 2.5 times below Amazon.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.
