Back on Nov. 8, I said Alibaba (NYSE:BABA) stock was breaking out to the upside following an earnings beat. At the time, I said a technical breakout was one of three reasons to buy BABA stock. Less than one month later, BABA stock is up another 6.8% to new 52-week highs. But the company’s new Hong Kong listing has given Alibaba bulls one more reason to go all-in.
On Nov. 26, Alibaba raised $11.2 billion by listing its shares on the Hong Kong Stock Exchange. Like any other secondary offering, the cash raised gives the company some financial flexibility at the expense of diluting shareholders. However, the Hong Kong IPO was also a strategically sound move to improve the stock’s U.S. valuation.
Alibaba is often compared to Amazon (NASDAQ:AMZN) due to its leading market share in the Chinese e-commerce and cloud services markets. Yet bulls have consistently been frustrated with its valuation discount to AMZN stock over the years. Alibaba has averaged 36.5% revenue growth over the past four quarters. Amazon has averaged just 20.2% growth during that same stretch. Yet AMZN stock trades at a forward price-to-earnings multiple of 64.7, while BABA stock trades at 22.7 times forward earnings.
Brand Recognition
One of the biggest reasons why AMZN stock gets more respect in the U.S. market than BABA stock is because Alibaba has negligible brand recognition in America, especially compared to Amazon. Almost all U.S. investors use Amazon on a daily or weekly basis. They know the service and they know the brand. To American investors, Alibaba is more of an abstract idea. Investors are understandably less comfortable putting money into a company when they are unfamiliar with its services.
Now, for Chinese investors buying Alibaba shares in Hong Kong, the dynamic is completely the opposite. Chinese investors are intimately familiar with Alibaba and its collection of brands. That familiarity will likely mean BABA stock will trade at a valuation premium in Hong Kong.
Fully Fungible
Each share of U.S.-listed Alibaba stock represents eight shares of Hong Kong stock. The shares listed in the U.S. and Hong Kong are fully fungible. “A fully fungible stock can be bought or sold in one marketplace to be converted or sold on another, and pricing on the two are unlikely to diverge too much from each other,” according to the South China Morning Post.
In other words, if Chinese buyers drive the price of the Hong Kong shares too high, sophisticated traders with access to both the U.S. and Hong Kong markets can simply buy U.S. shares and sell Hong Kong shares for a quick profit. In theory, this should keep the valuations of the two listings roughly in line. For U.S. investors, Chinese buying should spill over to the American valuation.
So far, that theory seems to be proving true. In the first three days following the Hong Kong listing, Alibaba’s Hong Kong shares gained 16%. In less than two weeks, the U.S. shares are also up more than 5%.
Other Catalysts for Alibaba Stock Ahead
While the initial excitement surrounding the Hong Kong listing is starting to die down, BABA stock has another potential catalyst just around the corner. Alibaba was added to the Hang Seng Composite Index yesterday. Inclusion in this popular index could open the door for institutional buying. Any fund that tracks the Hang Seng Composite will be compelled to buy an equal weighting of BABA stock. It’s difficult to say just how much buying volume will occur following the addition of Alibaba to the index. But every little bit of volume helps.
In addition to the Hang Seng index news, Alibaba’s technical picture is looking extremely bullish. The stock recently closed above $200 for the first time since mid-2018. The day it broke above $200 was also the highest volume day for BABA stock in more than a year, suggesting the breakout was legitimate.
Finally, the trade war has been a dark cloud over all U.S.-listed Chinese stocks throughout 2019. Alibaba does very little business in the U.S. But fears that the trade war will weigh on the Chinese economy have U.S. investors keeping their distance from Chinese stocks. Who knows what will end up happening with the trade war. But it is in the best interest of both the U.S. and China to reach some sort of a resolution eventually. Whenever that day comes, it could certainly trigger a relief rally in Alibaba stock.
As of this writing, Wayne Duggan was long BABA stock.
