Alibaba Group Holding Ltd (NYSE:BABA) delivered some pretty stellar earnings recently, and the momentum keeps pushing shares to new all-time highs. I’m going to run through the numbers quickly, but before we get all hyped up over them, I will also toss you some very legitimate concerns regarding why I’m not keen on investing in BABA stock.
Only the spiteful would have anything negative to say about the revenue increase of 60% year-over-year to $5.6 billion, which was driven by a 47% increase in core commerce to $4.587 billion.
Although the other divisions don’t account for large percentages of overall revenue, there were increases of 103%, 234% and 88% YOY for cloud computing, digital media and innovation initiatives, respectively.
A few other highlights:
- The retail marketplaces now have 454 million consumers, up about 3% from the 12-month period ended in December 2016.
- Mobile monthly average users hit 507 million, up from 493 million December.
- Non-GAAP net income was up 38% to $1.52 billion.
- For the full year, net income was $8.41 billion, an increase of 35%.
- Free cash flow was just short of $10 billion.
- Alibaba has $21.3 billion of cash on hand.
BABA stock trades at 36 times net income, good for a market cap of $315 billion at the moment. Now, one might argue that with net income growing at a clip of 35% year-over-year, not only is Alibaba fairly priced — including with a price/earnings-to-growth ratio of 1 — but it might even be a growth-at-a-reasonable-price (GARP) stock.
After all, growth stocks tend to trade at higher PEG ratios.
So … why doesn’t it? I think the market has priced in several risks that most investors overlook.
What’s Wrong With BABA Stock?
Back in November, I wrote:
“China is a difficult beast to understand, especially for Americans who have never done business over there. Crosscurrents regarding how the government operates are simply unknown quantities, and they factor into and affect how business is done. The Chinese government wakes up each morning with one focus: how to feed, clothe and shelter two billion people.”
Anything that gets in the way of that goal will be summarily removed. In short, this means that without any warning, China could suddenly turn on Alibaba (and therefore on Alibaba stock).
Here in the U.S., it’s rare for a sector to be taken totally by surprise by a sudden shift in government policy. We did see it with private prisons like The Geo Group Inc (NYSE:GEO) in 2016, and then it reversed after Trump won the election.
Still, there’s plenty of legislative and regulatory saber-rattling before something happens, and you’re very unlikely to see the U.S. government do anything that would shake up the likes of Amazon.com, Inc. (NASDAQ:AMZN) or eBay Inc (NASDAQ:EBAY).
Another ongoing risk is that the company is being investigated by the SEC over its accounting practices. We know from experience that, while everything may turn out fine, that if the SEC finds something materially wrong with Alibaba accounting practices, that could significantly harm BABA stock.
It’s also worth noting that state-owned Unicom Group engaged in “unprecedented degree of falsified revenue,” as reported by Bloomberg. This comes on top of local Chinese GDP data having been overcooked by as much as 20%. A friend who produces films in China has long told me that box office receipts are completely fabricated over there.
Fraud is simply a way of life in China, and that is the primary reason I have no interest in Alibaba.
The other domino in a chain that could lead to a major stock collapse is that foreigners are not permitted to own stock in Chinese web-based companies. Alibaba stock actually consists of ownership stakes in an offshore security known as a variable interest entity. All this does is give you contractual ownership of Alibaba’s profits … a contract not enforceable in China.
That may explain the valuation — a valuation that is still too elevated for me.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.