Shares of Alibaba Group Holding Ltd (NYSE:BABA) have been on fire so far this year, up a ridiculous 97%. However, I feel that BABA stock could have even more upside and at the very least, are setting up for a very low-risk, high-reward buy. Let’s take a look, shall we?
Alibaba now has a market cap of almost $446 billion, ballooning 185% in the last 20 months. Back when the Chinese e-commerce giant first went public, I didn’t know exactly what it did. People would say, “it’s like Amazon.com, Inc. (NASDAQ:AMZN), but not exactly”. Okay… so what does that mean?
E-Commerce is Just the Start
BABA has all sorts of business arms, from its own sites — Alibaba.com and Tmall.com — along with platforms and notable stakes in other companies. Sure, Alibaba is exposed to all sorts of e-commerce, but then there’s online video, social media, cloud computing and peer-to-peer financial platforms. It would be like mixing bits of Amazon, Netflix, Inc. (NASDAQ:NFLX), Alphabet Inc (NASDAQ:GOOGL) and Twitter Inc (NASDAQ:TWTR) all into one. And even then, one would still say “sort of” afterwards.
Combined with the fact that it’s based in China and not well known in the U.S. makes it difficult for American investors to truly understand Alibaba. BABA’s structure doesn’t make it any easier. Because the Chinese government isn’t too flexible on what assets foreign investors can own, Alibaba was forced to set up a complicated structure involving a holding company based in the Cayman Islands.
Long story short, this arrangement — or variable interest entity (VIE) — makes life quite complicated should a challenging legal situation arise. Because of this structure (and we literally only scratched the surface), it’s very, very tough to know what BABA stock ownership gives investors a stake in, what Alibaba owns and what founder/CEO Jack Ma owns. Trying to determine Alibaba employees, revenue and liabilities becomes even more complicated.
This difficulty to understand what’s what is one reason I avoided BABA stock two years ago. I wouldn’t say investors should avoid BABA for that reason alone, but recognize that it’s not a standard setup going into it.
Investors Do Understand Growth
While its legal setup may not be easy to understand, we can wrap our heads around growth. BABA stock may seem astronomically expensive, trading at almost 60 times trailing earnings. However, its 26 times forward earnings multiple is much more reasonable. While some investors may still find that figure troubling, consider Alibaba’s growth. Analysts expect the company to grow earnings almost 40% this year and another 34% next year. That goes along with an almost 50% sales increase this year and a 34% jump in 2018.
Facebook Inc (NASDAQ:FB) is a close comparison and it trades at 26.5 times forward earnings estimates. For comparison purposes, FB is expected to grow earnings 26% and 22% in 2017 and 2018, respectively, and sales 42% and 30% during the same periods. One could argue that BABA stock should trade a premium to FB shares given the former’s far superior growth.
I’m not saying Alibaba stock should have tremendous upside in the short term — it’s up ~100% this year after all — but this growth is incredible. In short, it’s a long-term powerhouse. Heading into the busy fourth quarter, one could make a case for Alibaba to push higher.
Trading BABA Stock
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BABA popped above the 50-day moving average in the first few days of trading this year and hasn’t looked back since, that is, until this past Monday. While both long- and short-term trend line support should come into play around $170, I am looking for a bounce on the 50-day moving average first.
Shares opened today at $174.69 and have pulled back below $172 as of 10:50 a.m. EDT. It’s not yet clear what the next few sessions may bring, or if it will justify a move back to $180 to $185 — the latter of which is the prior high. In short, I am looking looking for $170 and $175 to act as support. If not, perhaps $160 will come into play. Prior pullbacks — like this one — have worked out for the bulls this year.
Meanwhile, what two dates should investors keep in mind? First, Alibaba reports earnings on Nov. 2. The event could push BABA stock to new highs or knock it below all current support. Then there’s Single’s Day on November 11. The Chinese holiday historically shows a sales surge for Alibaba and shares tend to rally into the day. I am long BABA stock and looking for another push higher over the next few weeks.
As of this writing, Bret Kenwell was long call spreads in Alibaba. He is the manager and author of Future Blue Chips and is on Twitter @BretKenwell.
