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Is Alibaba Group a Buy?

Jeremy Bowman, The Motley Fool

Like most big-name Chinese stocks, Alibaba Group (NYSE: BABA) has had a rough 2018. Shares are down 22% year-to-date on a combination of factors, including trade tensions between China and the U.S., a slowdown in Chinese economic growth, and more recently, weakness in global markets following a selloff in U.S. stocks.

In contrast to its share price moves though, the e-commerce giant's revenue has continued to surge: It's up 57% through the first six months of its fiscal 2019 (through Sept. 30) to $24.2 billion.   Growth has been strong across the board as active customers over the past year increased by 25 million to 601 million, and in the most recently reported quarter, core commerce sales jumped 56% year over year to $10.6 billion, while cloud computing revenue soared 90% to $825 million. Performance was weaker in digital media and entertainment, where revenue increased by just 24% to $865 million. 

However, Alibaba's profit margins have narrowed due to the significant investments it has been making in local services, logistics, entertainment, and international expansion --  a strategy that echoes that of rival JD.com (NASDAQ: JD), which stepped up its own investments in warehouses, logistics, and technologies like drone delivery. 

Alibaba's acquisition of Ele.me, an online delivery service, and its purchase of a larger stake in Cainiao, a logistics service it co-founded in 2013, had the biggest impact on its bottom line for the period. 

Management also lowered their full-year revenue growth guidance in the recent report by 4% to 6%, putting it in the 50% to 53% range, due to a changing macro environment. The expectation is that shoppers will delay some purchases of big-ticket items. The company also intends to wait longer before moving to monetize some of its sellers' sales, in order to avoid driving them away from the platform. 

A sign at Alibaba headquarters

Image source: Alibaba.

The key numbers

Now that we have a sense of where Alibaba stands today, let's take at some the key numbers potential investors should understand. 

Based on Alibaba's last four quarters, the company has a very reasonable price-to-earnings ratio of 27, a function of shares having declined by more than a third from their peak this summer as investor sentiment soured on Chinese stocks. The Shanghai Composite has lost 25% year-to-date.

By comparison, the P/E ratio of the S&P 500 is 19; and surveying some of its fellow Chinese tech stocks, we find Tencent Holdings (NASDAQOTH: TCEHY) at 28, Baidu (NASDAQ: BIDU) at 16, and JD.com at 64. The broad selloff in the Chinese tech sector has made many of these companies cheaper than they've ever been on a valuation basis.

However, analysts anticipate Alibaba's strong revenue growth continuing, and expect its profit growth to return as well. The analyst consensus calls for earnings per share to increase 30% from $5.17 to $6.71, meaning the stock is trading at a forward P/E of just 20.

Time to buy?

With the much of the market in free fall in the past few months -- and with another downward slide following the Federal Reserve's decision to hike interest rates for the fourth time this year -- Alibaba's stock price  could easily head lower in the near term. Not only is market sentiment weakening, but there are some legitimate concerns about the company's performance. Operating profits are compressing, and management just cut its revenue guidance.

However, over the long term, the picture looks brighter. Alibaba is the leader in the fast-growing Chinese e-commerce industry, and its platforms like Taobao and TMall, with hundreds of millions of customers, are attractive marketplaces for companies foreign and domestic, including used car seller Uxin and athletic gear giant Nike, both of which have partnered with Alibaba recently. The company's marketplace model also gives it a cushion that rivals like JD.com sometimes lack, as e-commerce marketplaces generate much wider margins than direct selling does. IN addition, its cloud computing division should eventually pay off in much the same way that Amazon's and Microsoft's have profited them.

Though a deceleration in the Chinese economy could sink this stock further, it's well worth remembering that it's still growing much faster than U.S. economy -- and this company has a compelling position within it. It's putting up fast growth, owns an impressive network of competitive advantages, and is trading at a reasonable valuation. In other words, for long-term investors, Alibaba looks like a buy.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Amazon, JD.com, Nike, and Uxin Ltd. The Motley Fool owns shares of and recommends Amazon, Baidu, JD.com, and Tencent Holdings. The Motley Fool owns shares of Microsoft. The Motley Fool recommends Nike and Uxin Ltd. The Motley Fool has a disclosure policy.