August was quite the month for Alibaba Group Holding Ltd (NYSE:BABA), starting off with a joint venture with Marriott International Inc (NASDAQ:MAR). BABA stock bobbed up and down for a few days before starting a rally on August 11, ending the month up almost 11%.
The Marriott partnership was viewed as a sign that both companies believe in the secular growth narrative surrounding China’s middle class.
That narrative was probably one of the factors driving hedge funds into BABA stock, as evidenced by the 13F filings that came out in mid-August revealing notable buyers, including David Tepper’s Appaloosa Management, Dan Loeb’s Third Point, Stan Druckenmiller’s Duquesne Capital, and Julian Robertson’s Tiger Management.
Getting Better for BABA
As it turns out, those were smart buys and August just kept getting better.
Shortly after those 13F filings came out, Alibaba reported blowout first quarter results. The core commerce business saw revenues climb nearly 60% year-over-year. Meanwhile, cloud computing revenues nearly doubled; ditto for the company’s total profits. All in all, the report affirmed that Alibaba is China’s Amazon.com, Inc. (NASDAQ:AMZN).
After the earnings report, analysts raised their price targets, with Barclays and Needham & Co. both setting their sights right around $200 (implying more than 15% upside).
The net result of a new joint venture, big hedge fund buying, a huge quarter, and analyst upgrades? Double-digit gain for BABA stock versus a modest decline for the S&P 500 Index.
And the big August means Alibaba stock has almost doubled so far in 2017.
Can this run continue? I think so. Here’s why:
China Internet Growth Is On Fire
The bull thesis on Alibaba starts with the bull thesis on China. In two words: It’s booming.
The country is urbanizing and digitizing, meaning millions of people are entering the middle class and starting to actively use technology. The implication is massive growth potential in the Chinese e-commerce and social media spaces.
Recent quarterly reports from Chinese internet companies seem to support this bull thesis.
Alongside BABA’s blowout quarterly numbers, those other internet companies also reported strong quarterly results. 58.com Inc (ADR) (NYSE:WUBA), often dubbed the Craigslist of China, reported blowout second quarter results. According to management, jobs were the biggest growth driver in the quarter. Increasing job demand implies that China’s population is getting wealthier and that the middle class is indeed growing.
Things are also pretty good on the social media front. Though a slowdown in live video user growth weighed on the stock, China-based social networking platform Momo Inc (ADR) (NASDAQ:MOMO) reported robust revenue and earnings growth last quarter. The results underscore the thesis that China’s consumers are becoming more digitally connected.
Things are also booming on the e-commerce front. BABA reported blowout results, and so did Baozun Inc (ADR) (NASDAQ:BZUN), an e-commerce strategy company which focuses on marketing to big, multi-nationals that want access to the Chinese e-commerce market. The stock has struggled because of a capped out valuation, but growth continues to come in above expectations.
Overall, the Chinese internet growth story looks as strong as ever. Looking broadly, exchange-traded fund Guggenheim China Technology ETF (NYSEARCA:CQQQ) is up almost 38% in the past 12 months. The ETF’s top 10 holdings include WUBA and BABA stock.
BABA is at the forefront of this growth story, and that sets BABA stock up well for the next several years.
Bottom Line on BABA Stock
It all comes back to valuation, which is the only reason other Chinese internet stocks have pulled back despite great operating results.
But Alibaba doesn’t really have that problem. BABA stock trades at 26 times fiscal 2019 earnings that are expected to grow nearly 31% year-over-year. That is a price-to-earnings to growth ratio (PEG) of about 0.8.
You won’t find that sort of PEG in many other hyper-growth tech stocks.
Facebook Inc (NASDAQ:FB) also trades at 26 times fiscal 2019 earnings, but growth in 2019 is expected to be less than 22% (PEG of ~1.2). Amazon trades around 118 times fiscal 2019 earnings that are expected to grow more than 113% year-over-year (PEG of ~1). Meanwhile, Netflix, Inc. (NASDAQ:NFLX) trades at 86 times fiscal 2019 earnings for growth of about 70% (PEG of ~1.2).
Alibaba is undervalued relative to its hyper-growth tech peers. That means that if it continues to prove out this China internet growth story, BABA stock will head significantly higher.
I think that’s exactly what will happen. I’ll stick with BABA stock, even at these elevated levels.
As of this writing, Luke Lango was long BABA, FB, AMZN, NFLX, and BZUN.
