Recent earnings results from Alibaba Group Holding (BABA 0.59%) showed a return to growth. With a double-digit increase in net sales, a massive profit surge, and an increased emphasis on artificial intelligence (AI), Alibaba might appear ready for a comeback.
However, it has failed to bring long-term investor returns. And despite respectable earnings in the second quarter of 2023, investors should consider avoiding the stock for two reasons.
Alibaba's earnings
Alibaba might seem like a no-brainer buy when looking at its earnings in the second quarter of 2023. Its $32 billion in revenue rose 14% from year-ago levels. Operating margin was 18%, up from 12% in the year-ago quarter. This helped the company earn net income of $4.6 billion, an increase of 63% from the same quarter last year.
Moreover, investors will likely welcome some recent business decisions. it continues to build an AI community, creating a generative AI model for Alibaba Cloud and launching a scientific research and intelligent-computing platform with a research university in Shanghai.
And under CEO Daniel Zhang, Alibaba has sought to break itself up into six different companies. Under different umbrellas, the sum of the parts could easily become worth more than the whole, significantly benefiting shareholders.
The first reason to avoid it: The nature of Alibaba's stock
Alibaba trades with American depositary receipts (ADRs), meaning it is actually stock in a Cayman Islands-based holding company that issues legal certificates representing an interest in Alibaba. Usually, such arrangements are not a danger to investors, but when combined with political turmoil, they can become concerning, and this appears to be the case with Alibaba.
That situation likely explains why investors can buy Alibaba for around 20 times its earnings. This compares favorably to the price-to-earnings (P/E) ratios of its e-commerce peers in other parts of the world. Currently, Amazon sells for a 110 P/E ratio, while MercadoLibre investors will pay 87 times earnings.
That uncertainty may explain why, nine years after its initial public offering (IPO), the biggest challenge with this stock is investors' ability to profit from Alibaba's growth. Thanks mostly to bear market declines in 2021, a one-time gain of more than 230% was wiped out entirely. That means investors who bought Alibaba on IPO day and held it are losing money.
The second reason to avoid it: Tenuous relations with China
Also, Alibaba has come under fire in China and abroad. Founder and former CEO Jack Ma disappeared for months after criticizing the Chinese government, an action that coincided with a regulatory crackdown on his businesses. This might have led to the cancellation of the IPO of Ant Group, a mobile payments platform in which Alibaba holds an investment.
U.S.-China relations have also become more contentious amid leadership changes in the Chinese government. Consequently, U.S. companies have begun to move manufacturing out of the country.
Moreover, the Securities and Exchange Commission (SEC) warned Alibaba and other Chinese companies that a delisting could occur if the agency couldn't review audits of company financial statements.
The SEC withdrew this threat when it gained access to the audits, but such threats likely have a chilling effect on the stock. A delisting could wipe out the investment in these companies, posing a significant risk that shareholders in other companies do not face.
Alibaba stock brings unnecessary risks
Given the state of Alibaba, investors will probably do themselves a favor by avoiding the stock. While it looks like you can buy massive growth at a low valuation, this internet and direct-marketing retail stock experienced the total reversal of its all-time gains in a relatively short time. This occurred as both the company and the U.S. government faced tenuous relations with China.
Ultimately, managing risk is the key to successful investing. Thus, investors are likely better off buying an index fund or a competitor's stock than taking on the dangers associated with Alibaba.
