Alibaba (BABA) stock has tumbled in recent weeks as China’s growth continues to slow down, with China’s reported growth in 2015 being the slowest in 25 years. Weak economic growth in China has caused a selloff in Chinese and US markets, and the stock is now down 13% since the beginning of the year, closing below $70 on Tuesday. Short interest in Alibaba is rising as well.
Now might be a good time to see whether the bears are beating BABA stock down too hard…though for the record, I don’t think they’re being bearish enough.
Approach Alibaba Stock With Caution
Some investors might be tempted to buy BABA stock, thinking that shares might be worth buying now, given the company’s financials and expected growth prospects. Indeed, analysts give the stock a $95.54 price target, 36% above Tuesday’s closing price.
Alibaba might look cheap at first glance, especially in comparison with established Silicon Valley heavyweights, which trade at higher P/E ratios. Alphabet (GOOG, GOOG) trades at 29 times earnings, Facebook (FB) has a multiple of 95, and Yahoo! (YHOO), a huge investor in BABA stock, is 116 times earnings. Alibaba, on the other hand, trades only at 19 times earnings.
However, investing in Alibaba stock carries some risks. The company trades at over 13 times sales, so investors are pricing in high future revenue growth in the coming years and also expect that Alibaba’s profitability will not be eroded by new competitors. BABA may fall off of this expectations treadmill, either due to disappointing sales or narrower margins, causing a decline in the stock price.
BABA’s Growing Pains
Alibaba’s sales have ballooned in the past few years, but it may be difficult to keep up such strong sales growth as China’s economy cools and the Chinese e-commerce market matures. Expanding internationally will also be a challenge.
BABA will have to grow sales outside of China to sustain revenue growth, as China accounted for 98% of sales in 2015. Jack Ma wants Alibaba to generate 40% of sales from outside China, but it will face new challenges going abroad.
In overseas markets, BABA will have to compete more with established players such as eBay (EBAY) and Amazon (AMZN). Amazon and eBay are more globally diversified, earning larger shares of their revenue from outside their home markets than Alibaba does outside of China. About 38% of Amazon’s sales occur outside of North America, and eBay generates more than 50% of its revenue from outside the United States.
Alibaba will also have to maintain its high profit margin as well as rapid sales growth in order for BABA stock to catch up to its valuation. However, emerging competitors such as JD.com (JD) will battle Alibaba for market share within China. The Chinese market is becoming increasingly competitive, and JD is catching up with Alibaba. Either sluggish sales and weakening margins are serious risks to the BABA stock price going forward.
To add to this, there also are political, governance and regulatory concerns, including the stock’s unusual listing as a variable interest entity and problems with counterfeit goods being sold on Alibaba’s Taobao and Tmall marketplaces. Investing in Alibaba stock involves the risk that the market may re-appraise these risks if investors become skittish, causing a decline in the share price.
At the end of the day, BABA stock isn’t for the faint of heart, and after noting all these risks, I think it’s best for investors to avoid Alibaba in the near term.
As of this writing, Lucas Hahn did not hold a position any of these stocks mentioned.
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