China is home to the world's second-largest economy, and internet company Alibaba Group Holding Limited (BABA 2.92%) is one of China's most dominant businesses. Down more than 20% over the past year, Alibaba could prove to be a bargain for patient investors if they can look past a major red flag. Here are three reasons to buy Alibaba and one reason to sell it.
No. 1 reason to buy: Dominant business in China
According to Goldman Sachs, Alibaba dominates the e-commerce market with a 69% share as of 2020, making it the "Amazon of China." Alibaba has 912 million active customers in China and 1.17 billion globally. In 2020, the company did $1.2 trillion in gross marketplace volume, which is the value of all the transactions that pass through Alibaba's business.
The company's influence in China extends through a variety of business segments, including:
- Retail marketplaces
- Logistics
- Wholesale
- Cloud computing
- Digital media and entertainment
- Innovation initiatives and venture investments
Image source: Getty Images.
Alibaba also owns a 33% stake in Ant Group, a massive payments company in China that operates Alipay, which processes more than half of China's third-party payments. In other words, Alibaba has exposure to many aspects of the Chinese consumer and their economic activity.
No. 2 reason to buy: Stellar financials
In 2020, Alibaba grew its revenue 41% to $109 billion, helped by consumers embracing online services during the pandemic. In its 2021 Q1 (ending in June), the company grew rapidly, posting revenue of nearly $32 billion, a 34% increase from 2020. Alibaba is expected to end the year at $143 billion in revenue, a 30% increase.
The company is also very profitable. It converted $3.2 billion of its Q1 revenue into free cash flow and now has $72 billion in cash, equivalents, and short-term investments on its balance sheet. This gives Alibaba a ton of financial flexibility to start/grow new business segments or acquire emerging competitors.
No. 3 reason to buy: The stock is a bargain
Even though its share price has been slipping, Alibaba's continued growth is putting the stock at a lower valuation. The stock traded at a price-to-sales ratio of almost 8 last fall, but today it's under 4 using expected full-year revenue for 2021.
From an earnings standpoint, we can use the price-to-earnings ratio to get another look at Alibaba's valuation. The company is expected to earn $9.70 per share in 2021, resulting in a price to earnings (P/E) ratio of 20, roughly one-third of Amazon's current P/E ratio if we use its estimated 2021 earnings per share.
Alibaba's stock seems very inexpensive, considering its dominant position in China and its ability to grow its massive revenue by 30% -- all the while being profitable.
One reason to sell: The political risks aren't worth it
However, the political risk that the company faces has made Alibaba "uninvestable" for many, which is why the stock has lagged so far behind the market over the past 12 months. Regulators in China blocked the IPO for Ant Group last year, shortly after Alibaba founder Jack Ma made public comments about the financial system in China.
Alibaba was also investigated by Chinese regulators for anti-competitive practices and fined approximately $2.8 billion. In China, the government is very involved in the workings of Chinese companies, and these types of political risks are unpredictable.
It's unclear to investors what type of impact regulators could have on Alibaba moving forward, and it's a major red flag that has continually stoked fear among investors.
Here's the bottom line
Alibaba is a unique stock that offers investors growth, strong fundamentals, and an attractive valuation, yet is risky despite these positives. It's possible that the company indefinitely trades at a lower valuation than companies such as Amazon because investors might never fully be confident that political risks won't reappear in the future.
However, the stock is like a "coiled spring" that could unleash strong returns should investor sentiment turn more favorable. This upside makes Alibaba an interesting stock idea for bold investors.
