Fundamentally, the valuation assigned Alibaba (NYSE:BABA) stock seems almost absurd.
Relative to Wall Street estimates for 2021 ( and Alibaba already has reported results for the first nine months) BABA stock trades at 22x earnings. Look out a year, after projected earnings per share growth of 15%, and the multiple drops to 19x.
Back out Alibaba’s cash hoard of over $100 billion even net of debt, and forward price-to-earnings is just 16x.
Now, fundamentals are important, but they aren’t everything. That’s particularly true when we’re looking at estimates for just a single metric. And some investors might point to very real risks that suggest that BABA stock should trade at a discount.
Certainly, those risks can’t be ignored. But it’s also important to remember that we’ve been here before. This is not the first time that Alibaba seemed to facing material, permanent risks.
There have been supposed concerns about the company’s accounting. Skeptics have pointed to Alibaba’s VIE (variable interest entity) structure, in which U.S. investors don’t directly own Alibaba itself.
We had a big-time trade war that was going to put Alibaba in the crosshairs.
All of those worries had some merit. But each time, BABA stock powered through. I don’t believe this time will be any different.
The Risks First
Alibaba has a market capitalization of $662 billion. It’s the eighth-most valuable company listed on U.S. exchanges.
So the valuation assigned to BABA stock isn’t a matter of investors not paying attention or ignoring the stock. Again, there are reasons why investors have sold off shares over the past few months.
That’s not to say those reasons are correct, simply that they exist.
The big worry is on the regulatory front. Just last week, the Chinese government levied a $2.75 billion antitrust fine against the company. That was the highest penalty ever in the country.
That’s not the first move the central government has made. The proposed initial public offering of Ant Financial, in which Alibaba has a sizeable stake, was suspended in November.
We even saw speculation around the health of Alibaba’s founder Jack Ma after he disappeared from public view.
Those are not the only risks. Smaller competitors are gunning for Alibaba, with some taking market share.
And, of course, there are the long-running concerns about the Chinese economy itself. Some investors believe that the still nominally-Communist country is due for a crash.
Taking a Step Back
But all of those risks have a common thread. They only exist because Alibaba is, well, Alibaba.
It gets regulator attention because it’s a massive company. Every competitor is gunning for Alibaba because it’s the clear leader in Chinese online retail.
Big Tech companies in the U.S. often have similar problems, and similar challenges.
Now, yes, the Chinese and U.S. governments are of course very different. But let’s consider what the Chinese government has actually done.
It fined Alibaba less than $3 billion — or less than one-half of one percent of its market capitalization. And other penalties, like a reported requirement to divest media assets, hardly impact the core business.
$2.75 billion doesn’t sound like just a slap on the wrist, but it kind of is.
The Chinese government is trying to guide Alibaba in the direction it wants it to go. It’s not blowing up the company. Indeed, Alibaba remains a key part of China’s “belt and road” expansion in Asia and beyond. The idea that there’s some existential risk to the company and to BABA stock seems foolish.
The Right Focus for BABA Stock
I’m not saying investors should outright ignore the challenges Alibaba faces. I’m saying investors should put those challenges into their proper context.
Again, this is a business worth around $662 billion. It’s going to generate more than $100 billion in revenue in 2021.
It’s growing the top line at nearly 40% clip this fiscal year. The cloud business has massive standalone value. Alibaba has plenty of room to expand internationally.
There is so much good news — and yet BABA stock is cheap. It’s cheap even though the company is investing billions in growth efforts like the cloud business, logistics efforts, and brick-and-mortar retail.
Put simply, the big mistake with BABA stock is focusing on the risks. It’s the rewards that investors should pay attention to. Because, soon enough, that’s exactly what the market is going to do.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
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