Alibaba Has Lots of Potential, But It’s Still a Hold

Alibaba (NYSE:BABA) stock has been garnering a fair share of interest of late due to near record-high prices. Markets and investors are therefore trying to ascertain the ability for Alibaba stock to continue to rise.

BABA Stock Weakened Before the Coronavirus and Looks Worse Now
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Investors have trepidation regarding Alibaba with shares that are quite expensive, having recently touched $230. Not to mention, Alibaba may soon be subject to potential regulations which loom on the horizon.

That said, the company’s sheer potential for growth and price appreciation alone give it tailwinds that make it very difficult to dismiss. 

How Fairly Is Alibaba Stock Priced?

Alibaba is a growing company and as such, there are specific valuation methods applicable to evaluate BABA stock.

The Peter Lynch Fair Value is one such method investors can use to find a fair price markets should theoretically be willing to pay for shares in Alibaba. The ideal growth rate for which to apply this method is in companies with 10% to 20% yearly growth.

Alibaba’s five-year EBITDA growth rate is 24.52%. This is still well within range. Utilizing Alibaba’s trailing 12-month EPS of 9.29 ended March 20, we get a fair value of $227.70 for a share of Alibaba stock. 

BABA shares are trading at $236.51 at the time of this writing, so the stock would be slightly overvalued based on Peter Lynch Fair Value calculations. To be perfectly technical, we can say that they are trading at 103.8% of their fair value: $236.51/$227.70 = 103.8%.

Of course, this is simply a method by which to explain a reasonable price. 

This calculation is purely quantitative and can’t account for certain qualitative factors. In Alibaba’s case, one such qualitative factor, regulations specifically may soon play a large role in its share price. 

New Oversight Threatens BABA

Investors into Chinese businesses have long been scared away by the lack of transparency. Chinese companies listed on U.S. exchanges are not currently subject to the same scrutiny that U.S. based companies are. The Public Company Accounting Oversight Board (PCAOB) oversees audits U.S. publicly traded companies. The PCAOB is a division of the SEC. It was created in the wake of the Enron scandal with the goal of transparency and protecting investors from unscrupulous companies. 

The Holding Foreign Companies Accountable Act passed the Senate unanimously on May 20. The House of Representatives is currently deciding the bill’s fate. Should it pass there, it will go to President Donald Trump for his signature and then become law.

As the House releases information about the bill, Chinese firms’ share prices are sure to move. The Republican-controlled Senate passed the bill unanimously within seven weeks. The House of Representatives should give some indication of its decision soon as the bill has been there for a similar period of time. 

If the House passes the bill Chinese shares will drop in price. Should it become law, big changes will occur. Chinese companies including Alibaba will then be much more transparent. Then investors can feel much more secure that Chinese companies are truly investment grade. 

Recent Scandal May Hurt BABA Stock

The recent Luckin Coffee (NASDAQ:LK) debacle certainly accelerated momentum for this bill to become law. If you’ve not read about it, as an investor you really should. The scope and scale of the fraud is shocking. 

Chinese companies do not always the same as those in the West. So, Chinese companies listing on U.S. indices such as the New York Stock Exchange, the Nasdaq composite, etc. ought to be abiding by the exact same accounting practices as all others.

Then, and only then, can investors truly begin to make apples-to-apples comparisons between Alibaba and Amazon (NASDAQ:AMZN). And markets want the same transparency for all Chinese companies traded in the U.S. 

Hold On To Alibaba Stock

Alibaba is garnering a lot of interest given its parallels to U.S. retail giant Amazon. The company is massive, with great potential and a lot of growth yet to be had.

That said, I believe Alibaba to be a hold. BABA shares are actually pretty fairly priced despite the hype surrounding the company. The company continues to grow at a rapid pace, yet there are headwinds.

Given what transpired at Luckin Coffee, investors should at least think twice. 

At the time of this writing, Alex Sirois held no shares of any of the aforementioned stocks.

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