The Chinese e-commerce giant and internet conglomerate Alibaba Group (BABA 2.59%) had a troubled 2021, as it made headlines for various reasons and its shares tumbled by more than 40%.
The stock is now at its lowest valuation since it began trading on the U.S. market. But if you're thinking that the decision to buy cheap shares of a company that's dominant in the world's largest market should be a no-brainer -- well, not so fast. I'm avoiding Alibaba in 2022. Here's why.
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Its shares certainly qualify as cheap
Alibaba has thrived in recent years. Its revenue grew from 376.8 billion yuan in its fiscal 2019 to 509.7 billion yuan in fiscal 2020, a 35% increase, then by another 40% to 717.2 billion yuan in its fiscal 2021, which ended March 31, 2021. Revenue was up 32% year over year through the first half of fiscal 2022 (which ended Sept. 30, 2021). In U.S. dollars, analysts expect Alibaba to book total revenue of $135.7 billion in its fiscal year 2022.
The company is also profitable, posting 46.2 billion yuan in net income through the first six months of fiscal 2022, for a net profit margin of 11.3%. That's impressive considering the level of competition in the e-commerce industry and the worldwide supply chain and logistics issues that are the latest manifestations of the COVID-19 pandemic. Analysts forecast that even e-commerce giant Amazon will grow revenue at a lower rate this year and post a lower net profit margin.
BABA PS Ratio data by YCharts
Despite its strong operating metrics, Alibaba's stock price is continuing to slide. It now trades at its lowest price-to-sales (P/S) and price-to-earnings (P/E) ratios since it went public in late 2014. Its ratios are well below Amazon's P/E ratio of 63 and P/S ratio of 3.6, indicating that the market is discounting Alibaba's stock.
Valuation doesn't account for the destroyed shareholder value
To properly explain the discount on Alibaba's stock requires one to bring politics into the conversation. The company has been in the news repeatedly due to its interactions with the Chinese government.
Chinese regulators suspended the much-anticipated IPO of Ant Group in late 2020. That company owns AliPay, China's largest digital payments platform. The new company was expected to hit the market with a valuation as high as $310 billion, and Alibaba owns about one-third of Ant Group. Regulators ended up breaking up AliPay, forcing the company to split its user data into a separate entity that's partially owned by the Chinese state. It was a massive blow to Alibaba, virtually destroying the value that Ant Group would have had after its IPO.
Alibaba has also had direct run-ins with regulators, including an April 2021 investigation into the company for monopolistic practices. That resulted in a $2.8 billion fine.
Alibaba announced a plan to pledge $15.5 billion of its profits to China's "Common Prosperity" campaign, a state-led effort to invest in various agendas around the country to develop emerging populations and more evenly distribute wealth through its economy.
These are massive amounts coming straight from Alibaba's bottom line. The company had a total net income of 150.3 billion yuan in 2021, roughly $22.9 billion. As such, these expenses will slice a double-digit percentage out of the company's profits, even if it's spread out over five years. Yes, the stock is cheap by the numbers, but the Chinese government has destroyed a lot of shareholder value, which investors shouldn't take lightly.
The future is far from clear
Perhaps the most concerning thing for long-term investors is that nobody can guess what might come next. The Chinese government has set a precedent here. It can and will tap into its largest private businesses for what it views as the greater good of the country, which certainly signals that shareholders' interests will probably come second to the government's.
Who's to say that China won't decide down the road that it needs more contributions from tech companies like Alibaba? How can investors account for this when determining the potential risks and rewards of holding shares of Alibaba?
Factoring a margin of safety into the stock is one solution, where investors discount the price to reflect as yet unclear risks. Investors can look at Alibaba's prior stock valuations. Yet with the political risks and financial damage done over the past 18 months, one shouldn't assume that the stock will rise back to those higher valuations.
Investing is about finding and taking advantage of situations where the risk-reward calculus is favorable. But I'm having a hard time figuring out the equation for Alibaba.
The market has sold off many technology and growth stocks over the past year, especially during the last couple of months. Investors can look around the market and find other attractive opportunities where there isn't so much mystery around what might impact the stock down the road. That's why I'm not touching Alibaba in 2022.
