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Pros and Cons of Buying Alibaba Group Holding Ltd (BABA) Stock

John Divine

For years, analysts have called e-tailer Alibaba Group Holding Ltd (ticker: BABA) the "Amazon of China" and for good reason -- it's one of the few e-commerce companies in the world that can hold a candle to Amazon's ( AMZN) size and growth potential.

The online-only retailer, founded in 1999, went public in the U.S. in 2014. Alibaba's initial public offering was the largest ever IPO at the time, with a market cap of $231 billion. Anyone who bought into the BABA IPO and held has done quite well since then, as BABA now carries a market capitalization of nearly $460 billion.

It's hard to argue with doubling your money in five years.

One of the most glaring risks with Alibaba stock, however, is the ongoing U.S.-China trade war, which has lasted longer than many analysts initially expected.

[READ 7 Stocks With the Most to Lose in China]

That said, if and when a resolution is reached, BABA will have even greater potential than it does today.

BABA Stock at a Glance

Analysts and money managers seem to share a positive view of Alibaba, despite all the trade hullaballoo.

Alibaba stock is trading around $180 per share, and, although lower than where it was even 18 months ago, there remains massive bullish sentiment -- the consensus target price among the 47 analysts who track the stock is $222, representing upside of 24%.

Revenue grew by 40% last quarter -- a fabulous figure for a company of almost any size, but for the world's seventh-most valuable public company, that figure is borderline miraculous.

It makes a little more sense, however, when you take a look at Alibaba's incredible scale. Users simply love its products; active consumers grew by 19 million last quarter from the previous quarter to 693 million.

Mobile monthly active users ticked even higher, growing by 30 million in just three months, reaching 785 million. The company aims to serve more than 1 billion customers by 2024, and it looks as if it'll reach that goal.

Alibaba's growth, however, doesn't solely originate from its core e-commerce business segment.

Growth in its cloud computing segment clocked in at 64% year-over-year, while digital media and entertainment grew by 23% annually. Perhaps you see even more clearly why BABA is known as the Chinese Amazon -- like its U.S. peer, cloud growth is helping to fuel overall revenue numbers, and Alibaba has its own Prime Video-like streaming video offerings to boot.

Pros to Buying BABA Stock

As with many stocks, the best way to play Alibaba intelligently is by taking the long view.

This centers around the company's superb position in the world's fastest-growing major economy, a trend that's far more compelling and irreversible than the headline-grabbing but shorter-term trade war catalyst.

Alibaba's continued strength in e-commerce is fueled by its vast data insights on Chinese shoppers and its gain of market share in the cloud computing industry.

Like Amazon, Alibaba's once-small cloud division has burgeoned into a major part of its business, and a leading provider for its native country's top enterprises. In the most recent quarter, no other segment outside of its core commerce business was as large as cloud computing.

After 64% growth last quarter, it accounts for about 8% of Alibaba's overall revenue. In the same quarter three years ago, the cloud division made up just 4% of all revenue.

Yes, Alibaba does a lot well on its own accord -- you don't become a business of this size by being mediocre. But investors should also appreciate that BABA has a few secular and macro trends going for it; there's an incredible rise of the Chinese middle class going on right now, as more and more citizens are lifted out of poverty.

That extra discretionary income has proven to be crucial to Alibaba's sustained high growth. Also, it doesn't hurt to have the Chinese government as a safety net -- it's well-known that China subsidizes its star companies and goes to bat for them on the international stage.

BABA's American counterpart, Amazon, has the opposite dynamic, facing regular zings from President Donald Trump on Twitter, and, more materially, antitrust investigations from regulators.

It'd be foolish to say that protectionism from the Chinese government didn't work strongly in favor of BABA stock, helping to push it into the "buy" column.

"The most commonly cited reason for owning it is the belief that Chinese government policies favor domestic companies, preventing foreign players who might otherwise be competitive from seriously entering the market," says Bernard George, a former hedge fund portfolio manager and now CEO of Nvstr.com, a social stock trading platform. "Our platform users also believe their Singles Day commercialization has grabbed a lot of global mindshare."

[See: 10 of the Best Tech Stocks to Buy for 2019.]

Cons to Buying BABA Stock

Trade conflicts with the U.S. could derail BABA's impressive growth. Arguably the ongoing feud has already impaired Alibaba's results, which likely could've been even stronger in recent quarters if the U.S. weren't pressuring the Chinese economy.

Gil Luria, director of research for D.A. Davidson & Co., an investment banking company, spells out just how the trade war hurts a company like Alibaba.

"Not only would the cross-border piece of the business be impacted, a reduction in U.S.-China trade could also weigh on the Chinese consumer, which is driving Alibaba's domestic growth," Luria says. "Furthermore, growth in the U.S. is part of Alibaba's long-term strategy and is already being impaired by restrictions on Chinese investments.

"Alibaba shares are a good way to invest in the growth of the Chinese economy, but are also very much at risk from escalating trade tensions," Luria says. Should the apparent denouement in the trade war fall apart, don't be at all surprised to see BABA shares fall as well.

Other risks, as far as the stock market is concerned, are generally tame in the grand scheme of things. Still, it'd be imprudent to ignore them.

Firstly, the company is virtually without its enigmatic founder and longtime leader, Jack Ma, who stepped down as chairman of the board in September. Though he still holds a board seat, he'll step down from that position as well in 2020. There are always risks when a visionary entrepreneur -- the company's founder and former CEO, no less -- leaves the company. It remains to be seen what impact this will have.

Another risk, which may seem benign but can be quite ugly in practice, is the absurdly high bar the company has set for itself. Investors have come to take 40% growth at a $460 billion company as run of the mill; the day after Alibaba's most recent earnings were released, shares traded a mere 2% higher, despite crushing both top- and bottom-line expectations.

The risk is that when this growth inevitably decelerates, it'll have to decelerate at just the right speed for analysts, or BABA will likely experience a swift selloff from "what have you done for me lately" growth investors, of which there are many.

The Bottom Line on BABA Stock

Ultimately, Alibaba's continued success is likely. It's got one of the most enviable competitive landscapes of any company in the world.

Few economies hold more financial potential than China, and Alibaba's immense market share in a number of high-growth, scalable, tech-based fields (e-commerce, cloud computing, digital media and entertainment, etc.) makes it perfectly positioned to dominate in the years ahead.

That said, it's true that China isn't exactly the perfect home country a company could ask for -- the government can do whatever it wants at any time, and there's certainly a risk of excessive government oversight. Plus, the trade war must be taken into consideration.

[Artificial Intelligence Stocks: The 10 Best AI Companies.]

Even with Alibaba founder Jack Ma on the way out and these risks in mind, a quick look at Alibaba's valuation in comparison to its results over the last few quarters suggests that perhaps investors are paying too much attention to the trade war.

The stock trades at 32 times earnings -- despite revenue growth of 40% and earnings per share jumping 36% last quarter. As far as large-cap growth stocks are concerned, BABA stock is an absolute bargain; you won't find growth like that for such a low multiple. Perhaps that's not a surprise, with shares trading lower than they did 18 months ago.

Reward requires risk, as any experienced investor knows. Buying Alibaba stock at these levels is a calculated risk, and one that could pay off big -- either very quickly if the trade war dies down, or over the long-term, barring a sudden change in its momentum.

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