Alibaba Group Holding Ltd (NYSE:BABA) stock hasn’t been immune to the recent pullback in large-cap tech. Even after a modest pop on Wednesday, the BABA stock price has dropped about 10% from an all-time high touched just last month.
For the most part, I don’t think the pullback in the group is worth worrying about. I’ve written that the dip offers an opportunity in Facebook, Inc. (NASDAQ:FB) and provides a better entry point for shares of Amazon.com, Inc. (NASDAQ:AMZN). But as far as BABA stock goes, I’m not quite as bullish.
After recommending the stock for most of the year, I turned cautious on BABA in late October, with the stock modestly above current levels. And I still think caution is warranted. BABA continues to look reasonably valued, and growth remains impressive, but there are significant risks here that a more cautious market may not be willing to take.
A Change in Sentiment Toward BABA Stock
The BABA stock price has risen 97% year to date, but the stock hasn’t always been such a strong performer. Indeed, BABA opened 2017 modestly below its opening price on its very first day of trading on Sept. 19, 2014. In a less bullish market, many investors focused on the myriad risks facing the stock.
So, the obvious concern in the near-term is what, exactly, happens should that focus be renewed. This year, investors are ignoring the long-running accounting concerns that Ian Bezek detailed on this site last month. They’re ignoring the fact that BABA stockholders actually don’t own Alibaba, but rather a complex series of VIEs (variable interest entities).
Even from a business standpoint, there’s obviously a complacency around a Chinese economy that many observers viewed as questionable just a year ago. To be fair, on that front, BABA isn’t alone. Stocks of Chinese-facing casino operators have soared. Las Vegas Sands Corp. (NYSE:LVS) is up 28% YTD; Wynn Resorts, Limited (NASDAQ:WYNN) has gained a sparkling 82%. Alibaba rival JD.com Inc(ADR) (NASDAQ:JD) is up 49%, though its gains have stalled of late.
That’s an awful lot of valuation added to stocks that remain reliant on a nominally Communist-controlled economy whose growth figures long have been questioned. At the least, investors in BABA — and Chinese stocks more broadly — have all but discounted the “hard landing” worries that have dogged the category for years.
What Happens When the Market Turns?
Of the aforementioned group, the BABA stock price seems the most risk if that sentiment changes. Its opaque corporate structure and accounting have been compared to that of Enron. BABA shareholders don’t actually own the company — or get a vote. (To be fair, that problem hasn’t dissuaded investors from U.S. tech firms like Snap Inc (NYSE:SNAP) and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG), who have limited or no rights for minority shareholders.) The oft-repeated description of Alibaba as the “Amazon of China” is incorrect, because Alibaba doesn’t actually sell the items on its site.
If an investor believes that the broad markets and/or the Chinese economy are due for a breather, Alibaba stock probably is the last issue he or she should own. And it will likely be the first to fall should those fears spread. It’s worth pointing out that even in the modest pullback of the past two weeks, the BABA stock price decline has been close to double that of large-cap US rivals.
There is definite near-term risk here. Short interest is 15%+ of the float (although it’s less than 5% of shares outstanding). The chart looks a bit wobbly, even after a couple of positive sessions. With the stock having nearly doubled this year, some investors likely have taken profits. And in the event of another decline, more might look to do so.
The BABA Stock Price Looks Stretched
There is a case to be made that the risks are worth taking. The company’s cloud business — which I called a “secret weapon” back in February — continues to grow nicely. Valuation hardly looks ridiculous, with the stock trading at 27 times next year’s earnings per share.
That’s a discount to US peers showing similar growth. And at the end of the day, Alibaba still offers an opportunity to capitalize on the coming growth of the enormous Chinese middle and upper classes.
But Alibaba should trade at a discount to US peers — for the reasons cited above. For exposure to China, I’d much rather own JD, which is taking share from Alibaba and has a more traditional, more direct and more controlled e-commerce model. There’s risk in JD too — but not to the same extent. JD isn’t being widely accused of selling counterfeit goods and its shares aren’t actually ownership of a paper company in the Cayman Islands.
At $100, and even $150, a share, BABA was worth taking those risks. But as the stock weakens, sentiment may do the same. I’m not ready to join the short-sellers of BABA stock by any means. But at the least, I’d caution investors to keep their eyes open — and their trading nimble.
As of this writing, Vince Martin has no positions in any securities mentioned.