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6 Things You Need to Know Before Buying Alibaba Stock

Tezcan Gecgil

Alibaba (NYSE:BABA) may be one of the best Chinese companies, but Alibaba stock has been struggling lately. It’s not as if there’s no go reason, though.

BABA stock alibaba stock

Source: Charles Chan Via Flickr

The current rhetoric on U.S.-China trade issues has become the elephant in the room. Now that the FED’s interest rate decision is behind us, the markets will once again concentrate on China, namely the trade talks ahead of a meeting between President Trump and the Chinese President Xi at a G20 summit next week.

Thus investors have valid reasons to be concerned about the short-term volatility in Chinese stocks, including, the ecommerce giant. So what should BABA stock investors expect amid escalating tensions and the tit-for-tat retaliation between the two countries?

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Here are three pros for Alibaba stock and three cons.

Three Pros for Alibaba Stock

Leadership in e-Commerce in China: Alibaba’s current share of the Chinese e-commerce space is almost 60%.

The group operates through three main ecommerce sites — Taobao, a Chinese online shopping website, Tmall, a Chinese-language website for business-to-consumer online retail, and Alibaba.com, the group’s international trade site.

The three sites have hundreds of millions of users globally and host millions of businesses. BABA’s mobile monthly active users (MAUs) on its ecommerce platforms is now 721 million.

Many analysts believe that BABA stock’s bottom line is not going to be too adversely affected by these current trade wars as its business model is tied to China directly, decreasing the long-term risks of bi-party trade wars.

With a population of almost 1.4 billion people, China’s economic growth is still in its early stages and the Chinese middle class is likely to expand for a long time.

Furthermore, consumer disposable incomes are also going up, fueling growth in many sectors, including e-commerce.

In fact, the e-commerce market in China is forecast to almost double within the next four years to reach $1.8 trillion. Therefore, even if the Chinese economic growth pauses for a few quarters to come, the country’s growth potential is intact.

Growth in Cloud: BABA’s core ecommerce business contributes to about 85% of its revenue. Yet BABA is rapidly expanding into many other lucrative industries, including cloud computing infrastructure, digital payments, online entertainment, and food delivery.

With a population of 1.4 billion people, China is the largest country in the world. A rising middle class leads to higher consumerism, and that bodes well for many industries in China. One of those industries set to benefit is cloud computing.

Alibaba’s concentrated push deeper into cloud computing is increasingly being compared to the success of Amazon’s (NASDAQ:AMZN) cloud business. In cloud computing, BABA is now the market leader in Asia.

On May 15, when BABA released its quarterly results, both sales and earnings exceeded estimates. Total revenue came at $56.1 billion, an increase of 51% year-over-year (YoY). Investors cheered that BABA’s cloud computing revenue soared 76% YoY.

Alibaba has over 40% of the public cloud market in China. The market share of Tencent Holdings (OTCMKTS:TCEHY), its biggest competitor, is about 11%.

As a result of increased diversification as well as the growth in the cloud space, Alibaba’s total revenue is expected to grow by double-digit-percentage rates. Such a growth rate would indeed be impressive for a company with a market cap of $415 billion.

International Expansion: Finally, forward-looking investors may want to pay attention to BABA’s international growth numbers too. Currently, more than 90% of the ecommerce giant sales are made in China.

But BABA also has investments in start-ups in South Asia and Southeast Asia. Higher incomes and rising internet penetration rates are likely to strengthen both regions’ ecommerce markets and contribute to Alibaba stock’s bottom line.

Among the start-ups in those regions in which BABA has stakes are Paytm, an Indian digital-payments provider, and Lazada, a Singapore-based e-commerce company that is growing in overseas markets.

BABA is also looking to partner with European companies. Many European companies are still discovering new ways to enter the Chinese market, and BABA may enable them to connect with Chinese customers faster.

BABA’s mobile payment network, Alipay, is also seeking to expand in Europe. International growth will not only help increase the company’s bottom line, but it will also enable BABA to diversify away from China, lowering the macro risk of BABA stock.

Three Cons for Alibaba Stock

Upcoming Listing in Hong Kong: By the end of year, Alibaba is possibly going to Hong Kong for a second listing. There the company is expected to raise $20 billion.

BABA had delisted from Hong Kong in June 2012. Now there is speculation as to why the company wants to move closer to China in a second listing and raise cash. Both the bulls and the bears are debating Alibaba’s motives.

Is it because BABA management is worried about the trade wars?

Can BABA’s second listing encourage more Chinese companies to follow Alibaba to Hong Kong?

Does Alibaba need the cash for reasons investors do not know yet? Should investors therefore be worried?

The exact result of this listing is still hard to pin down. For example, Alibaba has recently announced a one-to-eight stock split. A lower price may lure more Hong Kong-based investors into buying Alibaba stock.

However, we do not know how its U.S. shareholders may react. One thing we can possibly count on is increased volatility in BABA stock price.

Shorter-Term Technical Analysis: Following the recent volatility in especially Chinese stocks, Alibaba’s technical picture is giving mixed signals, pointing to the possibility for more choppiness around the corner.

If you still believe in the bull case for BABA stock, you might consider waiting for a better time to get long, such as around the mid-$150 level.  In case of general weakness in the tech sector or negative global trade news, the markets may want to go back toward the 2019 low of $148.84 that was seen on May 31.

In the coming weeks, I do not expect BABA stock to regain its recent high of $195.72, which was last seen on May 3. Instead, BABA stock is likely to trade in a range, possibly between $170 and $150, for several weeks.

Expect nearer-term trading to be choppy at best, possibly until we have more clarity on the potential resolution of U.S.-China trade wars.

BABA Stock PEG Ratio: In addition to looking at technical analysis charts and options prices to gauge market sentiment, I keep an eye on a given stock’s Price/Earnings to Growth (PEG) ratio.

A PEG ratio of one means the market’s perceived value of the stock is equal to its anticipated future earnings growth.  For example, if a stock had a P/E ratio of 25, and the company’s projected earnings growth was 25%, then the PEG ratio would be one.  With the PEG number, investors can compare and contrast the relative value of a stock against other stocks.

I also compare the change in PEG with the change in a stock’s price within a given time-frame to gauge investor sentiment regarding a stock’s potential price increase.

In 2019, Alibaba stock is up over 20%. To me, given BABA’s current level of earnings growth in a global economy that currently offers plenty of questions, Alibaba’s PEG of 1.02 is still high.

In other words, I regard BABA’s stock price of about $165 as somewhat over-stretched. However, please remember that the PEG ratio is just one tool in investors’ arsenal.

Ultimately, earnings drive stock price growth. Therefore, I will be keeping a close eye on the company’s quarterly report expected in August.

The Bottom Line on BABA Stock

Alibaba stock offers U.S. investors the chance to invest in the growing Chinese consumer and ecommerce markets. Over the past two decades, the company has built a strong moat around its ecommerce. Now it is increasingly focusing on diversifying its revenue stream both in China and internationally.

Alibaba’s growth in ecommerce, cloud computing, and its other investments throughout China and globally make it a disruptor and a sound long-term investment.

Therefore long-term investors should view any decline in Alibaba stock as a good opportunity to buy into the shares.

However, traders with a short-term horizon should remember that there might be further volatility with a downward bias in Alibaba stock. The daily volatility of Alibaba stock is high, giving it a wide trading range, so short-term traders should proceed with caution.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

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