Shares of Alibaba (NYSE:BABA) are finally showing some strength after a prolonged and punishing pullback. BABA stock had fallen over 50% from the all-time highs reached a year ago before finding some footing.
Some of the selling was warranted given the exuberance of the previous rally and the ongoing concerns coming out of China. The dramatic drop has now come too far however.
Time to be a buyer of an undervalued and oversold BABA on any further weakness.
BABA Stock Joins Peers Under Pressure
Certainly Chinese stocks have been under pressure lately, and BABA stock hasn’t been immune. The combination of a potential looming Evergrande default and the regulatory clamp down by the Chinese government has caused investors and funds to flee anything China related. InvestorPlace contributor David Moadel took a deep dive on these very issues in his Sept. 17 article.
Volatility begets opportunity. It is important to remember that while growth will likely slow for Alibaba, it will still continue to grow. The latest earnings report from early August showed just that. Earnings were a solid beat at $2.57 per share versus estimates of just $2.22. Revenues were a tad light at $31.87 billion but still showed a 34% increase from the year ago period.
While revenues grew 34% from 12 months ago, the BABA stock price has fallen $110 points, or 45%, in that same time frame. The combination of a dramatically lower stock price combined with healthy revenue growth makes for much lower valuation multiples.
BABA stock is certainly cheap on a fundamental basis. The current price-to-sales (P/S) ratio now stands at just 3.52x. This multiple is just off the 10-year low of 3.4x reached Sept 24. It is also at a massive haircut to the median of 11.46x over the past decade.
Alibaba is decidedly attractive on a comparative basis to such megacap stocks as Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT). These stocks are both trading just off the highest valuation multiples in the past decade. MSFT, for example, carries a nearly 13x P/S ratio. This is over three times the current P/S multiple for BABA stock.
Technical Take on BABA Stock
Alibaba is looking good on a technical basis as well. BABA reached oversold conditions but is starting to strengthen. The nine-day RSI bounced off the 30 mark. MACD is also turning higher and looks poised to go positive. This would generate a buy signal. Momentum has improved and is turning higher as well.
BABA stock is trading at a big discount to the 20-day moving average. On previous occurrences, these indicators aligned in a similar fashion to mark significant lows in Alibaba shares.
Plus, Alibaba just put in another positive day and relative strength is improving quickly in Alibaba.
Alibaba is due to report earnings in early November so it is important to have the options expire before then to lower risk. Implied volatility is still high in BABA options at the 58th percentile due to the recent sharp sell-off. This means option prices are comparatively expensive and favors option selling strategies when constructing trades.
So to position to be a buyer of BABA stock on further weakness, an out-of-the money bull put spread makes intuitive sense.
How To Trade BABA
Sell the Oct 29 $135/$130 put spread for an 85 cents net credit.
The maximum gain on the trade is $85 per spread. Maximum risk is $415 per spread. Return on risk is 20.48%. The short $135 strike provides a 11.41% downside cushion to the $152.39 closing price of BABA stock. The spread also expires before earnings are released to eliminate any earnings related risk.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. Tim makes weekly appearance on TD Ameritrade Morning Trade Live, CBOE TV Vol 411, Business First AM Trader Talk and bi-monthly appearances on Bloomberg TV Options Insight to discuss options and volatility. Tim has also been invited for reoccurring appearances on CNBC’s Volatility Playbook.