Undervalued Alibaba Stock Could Easily Double in Price

Alibaba (NYSE:BABA) could easily rise well over 100% from its present price, despite its recent 30% run-up since July 1. The market is starting to realize, as I wrote in my last article, that Alibaba stock is not being priced anywhere near where it should be.

BABA Stock Weakened Before the Coronavirus and Looks Worse Now
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I showed in that article that Amazon (NASDAQ:AMZN) makes only about 20% more free cash flow (FCF) than Alibaba. However, its market value was 122% higher than Alibaba’s. So, in other words, theoretically, not looking at margins, Alibaba should be priced double its present stock price.

Here is how that comparison looks now. Amazon has a market capitalization of $1.73 trillion, but Alibaba is at $810 billion. That’s a difference is only 113.5%. Both stocks have run up together.

But, as I pointed out in my article, Alibaba still has a significantly higher FCF margin than Amazon. Since my last article Alibaba came out with its June quarter earnings and FCF. So, I have updated the FCF margins.

What Alibaba Is Worth Now

In the last 12 months to June, Alibaba made $21.2 billion in free cash flow on $77.6 billion in revenue or 27.3%. By contrast, Amazon made just $24.9 in adjusted free cash flow on $296.3 billion in sales or an 8.4% margin.

So, Alibaba has a 225% higher FCF margin than Amazon. Therefore, it deserves to have a much higher than double its present stock price given its higher margins.

I estimate that Alibaba stock is now worth $915 per share, or more than triple its current value. Moreover, a second way to value Alibaba is to use Amazon’s FCF yield, which is 1.44%. That implies Alibaba stock should have a price of $511.

The average of these two numbers gives you a price target of $713, which means Alibaba stock is still worth about 150% more than its current price.

What Analysts Say About Alibaba

A poll of 35 analysts by Yahoo Finance reports an average EPS estimate of $11.58 for the year ending March 2022. That puts the stock on a price-earnings ratio of just 24x earnings.

However, Morningstar says that the stock has had an average P/E ratio of 38.2x earnings over the past five years. That implies that sometime over the next year Alibaba stock may end up being worth $442 per share (i.e., 38.2 times $11.58).

That represents a potential gain of more than 50% over the present price. This assumes, of course, that Alibaba stock reverts to its average P/E ratio. And remember, and average implies that a significant number of observations could be well above that price. In other words, the stock could end up trading at what I estimated it is worth above $713.

Recently CNBC quoted a money manager, Mark Tepper of Strategic Wealth Partners, as saying that Alibaba is “a play on the growing middle class in China.” He said, “… you’re getting all the business that Amazon has at a discount.” This includes e-commerce, cloud, Alipay, and delivery.

What To Do With Alibaba Stock

One of the reasons that may be hindering Alibaba stock is the rise of U.S.-China tensions. There is no way to know how long that will last. So maybe Alibaba won’t exactly reach its full potential price in comparison with Amazon.

To simplify things, I suspect a more reasonable target may simply be a doubling of the present price. Now assuming this takes two or three years to occur, the average annual rise in Alibaba price could still be quite substantial.

For example, if it takes three years to double today’s price, the average compound return each year would be 26% per year. Moreover, if it took just two years to double, the average annual return would be 40% over the next two years.

These are great ROI numbers for the patient, value investor in Alibaba stock. Eventually, the market will come to realize this valuation discrepancy.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.


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