Alibaba Group Holding Ltd (BABA) Stock Is a Risky Pre-Earnings Play

BABA stock - Alibaba Group Holding Ltd (BABA) Stock Is a Risky Pre-Earnings Play

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Shares of Alibaba Group Holding Ltd (NYSE:BABA) have been on a tear in 2017, up nearly 80% year-to-date. Given the massive performance of BABA stock, it only seems prudent to re-evaluate it ahead of earnings.

Alibaba Group Holding Ltd (BABA) Stock Is a Risky Pre-Earnings Play
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Alibaba is set to report earnings on Thursday before the open. But here’s the thing with the company: It has massive momentum.

Once-hated, BABA stock has been on fire, climbing from $60 in early 2016 to a recent high of $160. As revenue growth has been accelerating, so too has the stock price.

It doesn’t hurt that big-name hedge funds have been adding fuel to the fire. Dan Loeb, David Tepper and Stanley Drunkenmiller have been gobbling up Alibaba stock. This, along with other managers and index funds, has kept a steadily rising bid under Alibaba.

BABA Stock: Friends and Expectations

Given Alibaba’s $404 billion market cap, finding a “peer” isn’t so simple. Particularly given the fact that its business isn’t exactly simple. It’s not exactly, Inc. (NASDAQ:AMZN) or Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) or PayPal Holdings Inc (NASDAQ:PYPL). But BABA has similarities. Unfortunately, when all three of those companies reported earnings though, it was either a muted reaction or a decline.

Additionally, several Chinese stocks trade with a strong correlation. Names like Alibaba, Tencent Holding Ltd (OTCMKTS:TCEHY) — which has a similar $395 billion market cap — JD.Com Inc(ADR) (NASDAQ:JD), Weibo Corp (ADR) (NASDAQ:WB) and Sina Corp (NASDAQ:SINA) all recently reported earnings as well. None of them traded higher. Sideways to lower has been the trend.

One exception is Baidu Inc (ADR) (NASDAQ:BIDU), which beat and rallied as a result. As a whole, these stocks have had strong earnings, but most have seen their shares fall post-earnings.

Analysts expect BABA to earn 93 cents per share on $7.15 billion in revenue this quarter, the latter of which is forecast to grow 48% year-over-year. Overall, analysts are looking for 46% sales growth this year (fiscal 2018) and 32.5% in fiscal 2019. Earnings are forecast to grow in the low-30% range for each of the next two years.

Valuation and Trends

Some may think that 25x-forward earnings is a high valuation. I would counter by saying that it’s a premium valuation, which is exactly what Alibaba deserves. Because BABA is growing its key metrics with so much force, it could be argued that its valuation is just. Another reason is China and its monumental trend.

By 2022, the Chinese middle class is expected to hit 550 million people. That’s roughly 1.75 times the size of the entire U.S. population. While a booming middle class is great for almost all industries, it’s especially great for the online community. In China, online use is very prevalent. Consumers didn’t grow up in China slowly building a brick-and-mortar empire like in the U.S. That’s one reason why technology companies have grown so big so fast in the country.

As the middle class become larger (and richer), companies like Baidu, Alibaba, Weibo and others will continue to gain momentum. Maybe BABA’s revenue growth won’t stay in the 40% to 50% range, but it could very well hover in the mid- to upper-20% or perhaps above 30% for years to come.

The fact that Alibaba is profitable and it has its hands in so many different segments — video, home speakers (like Amazon’s Echo), online sales, grocery stores (again, like Amazon’s move with Whole Foods Market, Inc. (NASDAQ:WFM)) and financial services — makes it seem like growth is unlikely to slow anytime soon. It reminds me of a profitable, faster growing Amazon.

Trading BABA Stock

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Looking at the chart, a breakout over $160 would be very bullish. A pullback to $135 should be a good buying opportunity, as prior support and the 100-day moving average should come into play.

In a nutshell, BABA stock is an online Chinese conglomerate with booming trends. That’s hard to bet against. It also explains why it has become such a fund favorite in the investment community.

Heading into earnings, Weibo had a one-day, double-digit rally on seemingly no news. Despite this — and against what I would do almost every time — I said investors could buy the stock. Shares initially moved lower, but gobbled up roughly all of its losses after a stellar earnings result.

It’s tempting to say the same thing with Alibaba stock. For those that are long and want to keep their chips betting with BABA’s massive trend, I don’t blame them. For those that are looking to get a horse in the race though, there’s nothing wrong with waiting.

Alibaba stock is up roughly 70% on the year and it will, at some point, endure some sort of pullback. I don’t love the fact that margins are shrinking, either. Additionally, all of its peers are showing that it’s been tough sledding post-earnings. When the risk is a declining stock and the reward is sideways price action, I don’t like that setup.

So while one can stay long BABA stock into earnings, I wouldn’t do my shopping until Alibaba reports.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, he did not hold a position in any of the aforementioned securities.

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