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It would seem as if investors fully appreciate the Alibaba (NYSE:BABA) story at this point. After all, Alibaba stock has gained 35% so far this year, most of it in the last two months. BABA now trades at an all-time high.
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But in the context of this market, the gains seem almost feeble. There is no shortage of online retail plays in both China and the U.S. that have doubled or better so far in 2020.
More importantly, even after the rally, Alibaba stock seems to trade at a discount to peers and the market. Year-to-date performance aside, the stock looks cheap.
At this valuation, investors still are treating BABA as if its growth is coming to a relatively quick end. Yet last week’s earnings prove that’s clearly not the case.
The Core Case for Alibaba Stock
At the moment, Alibaba stock trades for a little over 30x the consensus earnings per share estimate for fiscal 2021 (ending March). It’s likely those estimates will continue to rise after last week’s blowout earnings report. The average EPS estimate already has moved from $8.73 before earnings to the current $9.05.
30x earnings is hardly expensive. In fact, the earnings multiple assigned BABA is probably the lowest among major online retail names in both the U.S. and China.
That in turn would suggest that investors are pricing in decelerating growth. Yet we have no evidence of that deceleration. In fact, Alibaba continues to outperform. That includes last week’s earnings report.
In the company’s fiscal first quarter, revenue increased 34% year-over-year. Adjusted net margins compressed modestly, but Alibaba is investing behind its business. Adjusted EPS rose 28% YoY regardless.
In this market — in fact, in most markets — companies growing earnings 28% aren’t valued at 30x those earnings. Those numbers suggest a so-called ‘PEG’ (price to earnings to growth) multiple near 1. Investors long have seen a 1x PEG multiple as a sign of real value.
Unsurprisingly in a market near all-time highs, it’s hard to find those stocks. Alibaba stock, however, is one of them, or at least close enough.
Of course, one metric on its own doesn’t make a bull case. Fundamentals alone don’t determine whether a stock is attractive. Investors after all are buying a business, not just a stock.
But Alibaba stock passes that test as well — and with flying colors. This is a business with broad reach and leadership in so many key areas.
Obviously, Alibaba is best-known as the leader in online retail in China. But its cloud business is becoming the leader in Asia. Revenue in that category increased 59% year-over-year in Q2. The response to the novel coronavirus pandemic should drive further adoption.
Alibaba has a self-operated grocery retail chain. Its Cainiao Network offers “last mile” services in China. Youku Tudou is one of China’s streaming video leaders. Its user base increased more than 60% year-over-year in Q1.
There certainly is no company in China that can match Alibaba’s reach. And that doesn’t even count Ant Financial. Alibaba owns 33% of that digital payments play, and Ant reportedly is planning an IPO. With a potential valuation exceeding $200 billion, the stake in Ant alone could be worth as much as $25 per BABA share.
Again, even with the 35% YTD rally, Alibaba stock simply looks undervalued. The question is why.
Certainly, some investors may worry about China more broadly. But that country has rebounded nicely from its novel coronavirus pandemic. Chinese stocks on the whole have performed well; it’s not quite clear why BABA should lag its peers.
There are concerns that Alibaba stock could be delisted. The Trump Administration continues to rattle sabers about Chinese firms listed on U.S. exchanges. But a company of Alibaba’s size easily could meet any such requirements. Again, other Chinese stocks have been big winners this year.
There simply isn’t a good enough reason for the valuation assigned Alibaba stock at the moment. That suggests a simple, and likely, conclusion: the rally in the stock is far from over.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. As of this writing, Matt did not hold a position in any of the aforementioned securities.
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