American traders may think of Alibaba Group Holding Ltd (NYSE:BABA) as the Chinese Amazon.com, Inc. (NASDAQ:AMZN), but the market sure doesn’t value BABA stock that way. With Alibaba set to release Q2 earnings on Thursday, U.S. investors should be looking at the stock as AMZN at a bargain.
AMZN has been one of the best stocks in the market in the last two years. Alibaba has struggled since its highly anticipated 2014 IPO. In fact, since the beginning of 2015, AMZN stock is up an incredible 149%, while BABA stock is down 20%.
There’s no question that both companies are strong growth stocks. In the last three quarters, AMZN’s year-over-year revenue growth has come in at 31%, 28% and 22%. In Alibaba’s last three quarters, revenue growth came in at 33%, 26% and 27%. Both companies’ growth numbers are impressive, but if anything, Alibaba has a slight edge.
When it comes to valuation, the two stocks are like night and day. AMZN stock has drawn harsh criticism for its cult following and irrational valuation. Even with its incredible growth numbers, AMZN stock still trades at a ridiculously high forward price-to-earnings ratio of 74.1. BABA stock, on the other hand, trades at a forward P/E of only 20.8, nearly in-line with the S&P 500 average.
AMZN bulls often point to free cash flow as a more appropriate measure of AMZN’s true value. AMZN’s current price-to-free-cash-flow ratio is 50.2, which is extremely high. Alibaba’s P/FCF is 24.3, less than half that of AMZN.
AMZN and BABA Have Their Heads in the Cloud
One of AMZN’s biggest growth drivers in recent quarters has been its AWS cloud services segment. While most investors are familiar with the e-commerce segments of Alibaba and Amazon, not as many U.S. investors know the staggering growth of Alibaba’s cloud services business.
There’s no question, AMZN is the global leader in cloud services, as the Goldman Sachs chart below clearly shows.
AMZN generated roughly $8.9 billion in cloud revenue in the four quarters leading up to Q2. BABA only generated about $0.5 billion in cloud revenue. However, it was Alibaba, not AMZN that demonstrated the single highest cloud services growth rate in Q1. BABA’s Q1 year-over-year cloud revenue growth came in at 162%, up from 117% in Q4.
What’s Wrong With BABA?
After comparing Alibaba and Amazon, it’s puzzling why AMZN stock has done so well, while BABA stock has done so poorly. However, there are a number of reasons why investors are skeptical of BABA.
First, there is a fear among investors that the Chinese economy is in decline. It’s certainly true that China no longer seems to be generating the same blistering growth that it has in recent decades. However, China still delivered an impressive 6.7% growth rate in Q2, ahead of consensus estimates of 6.6%. By comparison, U.S. GDP growth came in at 1.2% in Q2.
Second, investors don’t trust the financial structure of BABA stock. BABA is set up as a “variable-interest entity,” meaning that shareholders don’t own a direct interest in Alibaba. Instead, they own shares of a company registered in the Cayman Islands that shares in Alibaba’s profits. While that may sound suspicious, it is a common structure for Chinese tech companies listed in the U.S., including Baidu Inc (ADR) (NASDAQ:BIDU).
Finally, earlier this year, BABA disclosed a Securities and Exchange Commission probe into its accounting methods. Alibaba founder and executive chairman Jack Ma welcomed the probe, and he believes it is “an opportunity for us to let them understand what we’re doing.” Ma added that he has complied with the SEC requests, and the company has nothing to hide.
BABA Stock Is Worth a Chance
If Alibaba’s problems scare you, here’s some reassurance: those fears are likely the only reason BABA stock is so much cheaper than AMZN. The good news is that the issues are already priced into the stock.
As investors gain more confidence in Alibaba in the years ahead, there’s no reason why BABA stock can’t produce the same type of long-term upside that AMZN has in the last 10 years. BABA investors may need to be patient. But buying now ahead of Q2 earnings is as good a time as any.
As of this writing, Wayne Duggan was long BABA.