While Charlie Munger is not as well known as his counterpart Warren Buffett, the two have worked together at Berkshire Hathaway (BRK.A -0.34%) (BRK.B -0.01%) since 1979. Their distinct value investing style is iconic, and they know a bargain when they see one. While Munger's main allegiance is with Berkshire, he also manages Daily Journal Corporation's (DJCO 1.97%) investment portfolio.
The Daily Journal's latest 13F filing -- a report filed to the SEC when a managed portfolio has assets of more than $100 million -- showed a 99% increase in ownership of Alibaba (BABA 2.59%), which now makes up 28% of the Daily Journal's portfolio. Caught in the crossfire between the Chinese and U.S. governments, Alibaba has had multiple negative news headlines plague its stock over the last year. With an average Wall Street analyst price target of $201.94 and a current price in the low $120s, the stock has more than 60% upside. Does that mean you should join Charlie Munger and buy Alibaba shares?
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A worldwide giant
Alibaba can be described as a Chinese Amazon (AMZN 1.30%). It operates an e-commerce platform that is accessible in China and across the globe. Its retail sales are more than 12 times greater in China than internationally, with revenue of CNY 127 billion ($20 billion USD) in China versus CNY 10 billion internationally ($1.6 billion) during its second quarter (ending Sept. 30, 2021). Sales in both geographic regions grew 33% year over year, better than Amazon's 4% sales increase in the comparable period.
Cloud computing is another shared segment between Alibaba and Amazon. However, the future of the Alibaba cloud in the U.S. is questionable. The Biden administration recently opened a probe into how the cloud segment stores U.S. personal data. The U.S. government does not want China to have access to business or consumer information stored on Alibaba's cloud servers. Last quarter, its cloud computing segment grew 33% to CNY 20 billion ($3.1 billion), but if the company is barred from operating in the U.S. it could have a serious financial impact.
Alibaba also has a 33% stake in Ant Group, a fintech company. Ant Group provides many modern financial services like buy now, pay later and Alipay, China's leading digital payment platform, to its customers. It was scheduled to go public in the U.S. at around a $200 billion valuation, but the Chinese government halted the IPO, preventing Alibaba from profiting from its investment in the short-term. As of now, there are no plans for the IPO to go ahead.
A cheap stock with strong financials?
During Q2, Alibaba's revenue grew 29% across all segments. It brought in CNY 200 billion ($31.6 billion) and sported a 7.5% operating margin. Alibaba had some unfavorable investment income during Q2, which drove down its earnings. Management expects 20% to 23% revenue growth throughout 2022. This would mark a significant revenue slowdown for Alibaba, so ensuing earnings reports must be examined to keep up with these expectations.
Alibaba has an extremely low valuation relative its historical levels, trading at only 16 times earnings. It has seen its price-to-earnings (P/E) ratio drop significantly over the last three years. This stat is is exaggerated by Alibaba's low earnings in Q2: The denominator in the ratio is artificially low.
BABA PE Ratio data by YCharts
At this range, many would consider Alibaba a value play. Without that designation, Charlie Munger likely would not have invested in it. When evaluating the stock using the price-to-sales ratio, the decline in valuation is even more dramatic.
BABA PS Ratio data by YCharts
It's hard to deny how cheap Alibaba's stock is, but are the risks of owning the stock driving this low valuation?
Plenty of risks
Alibaba is associated with a lot of geopolitical risks. The U.S. government has contemplated delisting Chinese stocks from U.S. exchanges for not complying with regulatory standards the rest of the listed companies must follow. Should this happen, the companies will likely relist on the Hong Kong exchange. While this may be annoying, brokerages will handle this transition, and any shares owned can still be traded. This should give shareholders confidence that their investment won't go to zero should the delisting occur.
Alibaba and Ant Group's founder, Jack Ma, found trouble with the Chinese government in early 2021 after speaking out against how the government regulates business. After the comments, he disappeared from public life for about three months. If the government can control China's former richest man, then it can impose its will on all of Alibaba's management and potentially force it to do what is right for China, not for shareholders.
Additionally, China levied a $2.8 billion antitrust fine in September against Alibaba for allegedly not allowing its merchants to list on other commerce platforms. Both the Chinese and U.S. governments have their eyes on Alibaba, and investors must be aware.
Overall, Alibaba is an attractively valued stock with a solid business and a great investment in Ant Group. However, too many risks are present for me to invest in the business right now. If investors can stomach the risks, I think they can still do well by buying and holding the stock for at least three to five years. In the meantime, price swings caused by political headlines will be rampant, but those will probably have more bark than bite.
