When Alibaba (NYSE:BABA) traded at an all-time high of $230 at the start of 2020, China’s e-commerce giant enjoyed nothing but good news. The U.S.-China trade war ended with phase one in place. Markets as a whole enjoyed rich valuations. And once again, investors bought up Alibaba stock to get exposure to the Chinese stock market.
But last week, sentiment shifted to the downside. Growing worries over the impact the coronavirus will have on China’s economy worsened. Though the recent dip is modest, should investors consider buying Alibaba at around the 25 times price-to-earnings ratio?
As history often shows, timing the entry point with BABA stock is nearly impossible. So, investors may look at the recent dip as an entry point in a solidly growing firm. After all, the long-term growth prospects of the company look bright.
Alibaba Benefits From Cash Raise
In December 2019, Alibaba added 75 million shares to its listing in Hong Kong. This multi-billion cash raise strengthens the company’s balance sheet. In addition, the Hong Kong listing attracts Asian investors, increasing its liquidity on the stock market.
Adding $12.9 billion to its balance sheet will allow Alibaba to pursue strategic acquisitions, accelerate investments in its cloud computing service and grow its mobile e-commerce business. In its September 2019 quarter, Alibaba’s revenue grew by 40% while its cloud computing revenue grew by 64%. But that $1.3 billion is just a fraction of the $16.7 billion in quarterly revenue.
Alibaba’s 53% cost of revenue is unchanged from last year. Sales and marketing expenses of 9% of revenue are slightly lower. So, the company has room to increase its marketing, research and development activities to expand its already strong moat.
Sustained Long-Term Growth
Whether the ongoing virus outbreak hurts this quarter’s demand remains to be seen. But the long-term revenue growth profile continues to get better. Strong core commerce profits let Alibaba invest back into the business. As it adds value to its customers, long-term profits and revenue will continue expanding for years to come.
Alibaba’s digital media and entertainment performed well in the last quarter. Investors are essentially getting a Disney (NYSE:DIS) or Sony Entertainment (NYSE:SNE) type of company along with Alibaba stock.
Alibaba consolidated its Pictures unit, so the simplified structure should increase overall transparency. Still, the company already reports free cash flow (FCF) in a clear manner. In fact, the 90% increase in FCF to $4.3 billion underlines the business strength Alibaba enjoys. This will more than offset the increased capital expenditures and licensing fees.
If Alibaba expands its content library and incurs higher licensing costs, that will help it grow its user base. The company has 10 digital and media entertainment brands to grow. For example, UC, UC News and Tudou are some of the units that contributed to the $1 billion in revenue last quarter.
Valuation
Investors may reasonably expect Alibaba to grow its revenue by at least 33% in the next five years. So, at a conservative discount rate of 12.5%, the stock’s fair value is $265.
On Stock Rover, Alibaba stock has a quality score of 97. But the value score is just 61, due to the price-to-earnings ratio of 25.5 times and a price-to-sales of 8.7 times. By contrast, the S&P 500 has a P/S of 2.4 times.
My Takeaway on Alibaba Stock
Alibaba is a high-quality stock relative to the others listed on the Chinese markets. Investors should add the stock to their watch lists and wait for the selling pressure to ease. Even if the stock falls further, the long-term growth will justify holding its shares.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.
