The Pros And Cons Of Investing In Alibaba Stock (NYSE:BABA)

The dramatic rebound of BABA stock

The wild swing in the past week in the share price of Alibaba Group Holding Limited (NYSE:BABA) can be described as the absolute roller coaster ride of the decade for a mega-cap company. An investor who had been cut off from the internet from the end of February until Friday (March 18, 2022) would have no clue that BABA stock, the most well-known Chinese stock in the world, plunged nearly 30% at one point.

This was because BABA stock rebounded so strongly on March 16 that all the losses it suffered in March were completely erased. The share price of Alibaba Group soared 36.8% ($28.22) on that day, pushing BABA back above the psychological $100 level to $104.98 at the close.

What was the trigger for the dramatic rebound in BABA stock? It wasn’t the typical dead cat bounce effect. It was thanks to a loud and clear statement on Beijing’s support (content in Chinese) of the Chinese economy and the capital markets following a meeting of the top finance policy body chaired by Chinese Vice Premier Liu He.

Most pleasing to the ears of foreign investors was the specific address of the issues related to Chinese ADRs. It was revealed that “the regulatory agencies of China and the United States have maintained good communication, and have made positive progress, and are working on forming a specific cooperation plan.”

The statement also reiterated the Chinese government has continued “to support various types of companies to list overseas.” With the news released while Americans were asleep, shares of Chinese ADRs were slated to explode right from pre-market trading hours in the U.S.

The strong momentum carried throughout Wednesday as media reports carried positive takes on the statement progressively. For instance, I believed the order to the “relevant departments” to set up “both red and green lights… to promote the stable and healthy development of the platform economy and improve international competitiveness,” was viewed particularly favorably by investors as commentaries streamed in.

In my opinion, Beijing wanted to signal to market players that it was cognizant of the detrimental impact the regulatory crackdowns had on sentiment. It may seem like an obvious consequence, but the officials had to refute allegations they were oblivious to the gyrations the stocks were suffering from with their actions.

While the Chinese political leadership does not intend to let up on fixing the freewheeling practices of the internet platforms, it is endeavoring to establish more transparent policies detailing the rationale of the regulations and defining the boundaries. By doing so, critics could be in a weaker position to accuse Beijing of being frivolous and draconian. This would go some way to ameliorate the uncertainty discount on the Chinese ADRs.

The second part of this order (“improve international competitiveness”) should make many analysts and investors excited as it suggests Beijing might be considering to relent on the regulatory whipping on its internet giants like Alibaba Group so that they can regain their footing and become substantial global players. For the latter to happen, these companies must have steady revenue growth and profitability to facilitate investments in research and development as well as acquisitions, such that they can be powerful enough to take on the likes of Amazon.com, Inc. (AMZN), Meta Platforms (FB), and Alphabet (GOOG)(GOOGL).

This must sound like music to the ears of BABA shareholders! What caused the apparent U-turn by Beijing? Well, it’s anyone’s guess. My take is that having seen Russia becoming a pariah state in a matter of weeks, the Chinese government might have decided China needs to have a stable of local companies which are global champions in their fields.

In the event of hostility for whatever reasons, whether due to its actions or resulting from a Cold War, national governments would think twice about sanctioning Chinese titans lest it backfires on their local economies. That is more paramount in safeguarding China’s interests than simply ensuring self-sufficiency as China has long protected itself from the risk of American and European firms taking actions of their own or doing the bidding of their governments in contrary to Beijing’s wishes, like what Facebook and Google have done in Russia in the past weeks against the Kremlin’s desires.

China has its dominant messaging apps in the form of Tencent Holdings’ WeChat and QQ (OTCPK:TCEHY)(OTCPK:TCTZF), search engine giant Baidu (BIDU), food delivery and lifestyle services platforms like Meituan (MEIT)(OTCPK:MPNGF)(OTCPK:MPNGY), and e-commerce platforms such as Alibaba’s Tmall and Taobao, JD.com (JD), and Pinduoduo (PDD), among other essential services.

BABA Stock Key Metrics

The above write-up is based on the latest developments, but technical analysts would say the charts already foretold the outcome. On Tuesday, BABA stock hit a six-year trough of $73.28, just $15.89 shy of its lowest ever since going public. In other words, BABA stock was just hovering over its support-of-the-last-resort, something apparent when you look at the following price chart.

At the same time, BABA’s RSI sank below the 20 mark again on Tuesday, only the second instance this has happened since the IPO of Alibaba Group in 2014. When you exclude the first occurrence in late 2021 because of the recognition that shareholders sold in droves to benefit from tax-loss selling in December, Tuesday’s RSI became extraordinarily low. Thus, BABA was due for the proverbial dead-cat bounce in any case.

Fundamentally, the recent dip took BABA’s price-to-earnings ratio to single-digits for the first time. BABA’s price-to-sales ratio also hit a record low of 1.5 times. This could have triggered the buy signal in many investors’ systems, whether manually monitored or executed algorithmically.

The strong rebound returned BABA to the still low, but at least more plausible PE of 13.2 times and PS of 2.2 times. Juxta-positioning AMZN stock’s valuation multiples with BABA, the latter looks highly undervalued relative to their historical levels. Bargain hunters could have deemed BABA at a PS below 2 times was simply irresistible.

Pros Of Buying Alibaba Stock

We have discussed several pros of buying Chinese stocks like BABA previously What Are The Pros And Cons Of Investing In Chinese Stocks? including the undervaluation due to unjustified selling, favorable macro backdrop, and the optionality that the worst-case scenario does not materialize. In this section, I would argue that for the savvy investors not deterred by the multitude of challenges faced by the Chinese internet stocks and the moral dilemma, buying BABA stock is more advantageous than buying KraneShares CSI China Internet ETF (KWEB) for diversified exposure to the sector.

BABA is a superior proxy to KWEB for exposure to the Chinese Internet sector

Comparing the performance of BABA stock with the KWEB ETF from Alibaba’s public listing in 2014, BABA has provided a superior total return than the KWEB ETF, returning 6.9% in the period, versus -11.3% for the latter. On a past one-year basis, the story is the same, with BABA stock declining a lower 57.0% as compared to -65.2% for the KWEB ETF. Year-to-date, BABA is down 15.5% while KWEB has dropped 21.9%.

Secondly, the KWEB ETF comprises dozens of component stocks while BABA is just one – Alibaba Group Holding Limited. If you think that Alibaba alone is difficult to track and analyze, imagine the effort required to study KWEB. While it may suffice to research the top few holdings of KWEB that would have the largest impact on the ETF commensurating with their sizes in the portfolio, some readers may also want to scrutinize the manager’s track record, fees, and responsiveness to queries before deciding to invest.

Furthermore, while KraneShares, the manager of KWEB, has actively been switching their ADR holdings to the Hong Kong-listed shares in the past months, there remains 6.7% of the portfolio flagged as “anticipated US to HK relisting.” By a simple math calculation, even factoring this 6.7% switching exercise as completed, over one-fifth of the portfolio (21.5%) would be shares listed in the U.S.

I suppose these shares belong to companies like Kanzhun Limited (BZ) and Pinduoduo that have yet to seek listing elsewhere, Hong Kong or otherwise. In the worst-case scenario where they are unable to do so in time and they are named by the U.S. Securities and Exchange Commission [SEC] for non-compliance with the Holding Foreign Companies Accountable Act (HFCAA), KWEB could be dragged down together with these stocks.

All these issues significantly increase the homework required and yet the returns are poorer as seen in the selected periods of comparison presented in the above charts. Nevertheless, investing in an ETF like KWEB would certainly help in preventing your entire investment from being wiped out if a single stock becomes decimated, like what we have seen for those in the after-school tutoring industry. However, a niche ETF like KWEB focusing on the Chinese internet space is unlikely to perform antagonistically from the woes facing the entire sector.

Hence, it is important to know one’s reason for choosing between KWEB or BABA. If an investor is betting on the opportunities presented by the macro backdrop, industry prospects, and/or for what he deems as the irrational market, he may be better off buying BABA, or the Hong Kong listing, HKSE:9988.

Alibaba Group is oozing with cash and has a high free cash flow yield

In a tightening liquidity environment, it may be comforting for shareholders to know that Alibaba Group has $55.74 billion in net cash, more than its Chinese rivals and Amazon.

During the past weeks’ crash, BABA’s free cash flow yield had soared to above 12%. The current 8.88% FCF yield is still highly attractive compared to JD and Pinduoduo. AMZN’s FCF yield is -0.89%.

Beijing’s wrath towards Alibaba is turning into an embrace

Last but not least, as mentioned earlier in the introduction, the Chinese government has expressed a willingness to reevaluate the way they conduct their regulatory crackdowns. In any case, after a year of fixing, there probably aren’t many more outstanding issues to keep picking faults at the platform operators like Alibaba Group.

Furthermore, if Beijing is now serious about improving the international competitiveness of their local giants, Alibaba Group and its numerous units like fintech arm Ant Group could stand to benefit tremendously from China’s fast-expanding global network as facilitated by the Belt and Road Initiative. After all, Beijing’s concern is on protecting the rights of the Chinese consumers and perhaps ensuring the major shareholders of its private enterprises don’t get too big-headed thinking they can walk over the authorities.

Chinese manufacturers are already deemed indispensable for global consumers. If internet companies like Alibaba Group can offer the world enduring services like how ByteDance’s (BDNCE) TikTok and fast-fashion shopping app SHEIN have done, it is hard to believe why Chinese President Xi Jinping’s administration wouldn’t be happy.

Critics can say this doesn’t mean shareholders would be rewarded. However, note that the aforementioned statement by the top financial committee body in China said: “the Chinese government continues to support various types of companies to list overseas.” Since Beijing continues to desire overseas funding to support its economic growth, and they think in terms of decades, it is only to be expected that they will endeavor to protect the interest of foreign shareholders in order to continuously attract fresh investments.

Cons Of Buying Alibaba Stock

Many of the negatives for buying BABA stock have been repeated ad nauseam, whether for fear-mongering or risk disclosures. It is important to note that none of the major risks have materialized, whether it was trumped-up allegations that the Chinese government was planning to repudiate Variable Interest Entities [VIEs] or delisting concerns due to the much-hyped HFCAA.

However, Chinese ADRs like BABA are already behaving like they are guilty as charged and shareholders are painfully nursing our wounds. Despite the fact that many stocks have lost billions in market capitalization faster than Alibaba did, it is the latter that has earned the ignominious label of being “uninvestable” as JPMorgan analysts declared Alibaba, Baidu lead Chinese tech stocks south as downgrades say it’s time to sell just two days before the remarkable rebound in Chinese ADRs.

Consider Sea Limited (SE), affectionately known as the Tencent of Southeast Asia. SE’s market cap plunged more than 75% in a matter of five months from its high, a feat that took BABA more than a year. Yet, take a look at the various Wall Street analyst reports and commentaries on SE’s stock. They ranged from saying the market is irrational to investors throwing the baby put with the bathwater, alluding to the downdraft experienced by the entire tech sector.

Critics may say I have a bone to pick on Sea Limited. Well, it is because the strong reactions to my December coverage calling for a Sell on SE stock were memorable. It would be rare for anyone to profess that kind of bullishness on BABA stock without getting condemned for being foolish or naïve.

Investors also have to contend with the consequences to BABA stock with perennial concerns over China’s potential invasion of Taiwan and the implications. Presently, the potential imposition of sanctions on China for aiding Russia is also clouding the investment thesis. The former could take years, but the latter is a very near-term risk.

Thus, the true con of buying BABA stock is the relative ease to push the negative narrative and turn the sentiment to bearish. The sell-on-rumor phenomenon is particularly pronounced for Chinese stocks like BABA. Hence, investors would need a huge safety margin, which BABA is arguably offering right now, and nerves of steel to avoid selling during moments of panic.

In other words, BABA is not for the typical retail investor or even an inexperienced fund manager. Although BABA had pleasantly surprised shareholders on Wednesday as we woke up to the huge pre-market trading jump, it is certainly not a “Sleep Well At Night” SWAN stock.

That said, I am not asserting there will be a resolution on the HFCAA. The Chinese securities regulators may not be able to fully satisfy the demands of the SEC. Furthermore, while Beijing has reiterated their implicit support for the VIE structure, confidence in Chinese ADRs would likely continue to be shaken the next time a short-seller or other parties with vested interest stirs up this issue. The line “citing people familiar with the matter” would be authoritative enough to create fear, uncertainty, and doom, as the average investor is unable to verify on our own.

Bottom Line

Early last week, we saw Wall Street analysts capitulating and quickly reversing their bearish stance mid-week citing Beijing’s clear support of the capital markets with the release of a positive statement following a meeting chaired by Liu He, Chinese President Xi’s right-hand man. Chinese ADRs turned from being “uninvestable” to “highly undervalued” in a matter of days.

It is convenient to say “avoid Chinese stocks.” However, what options do investors have in seeking alpha? SaaS and pandemic-related stocks have also seen huge evaporation of market value. American stalwarts like Facebook, Netflix (NFLX), and Tesla (TSLA) are also down significantly year-to-date.

Considering that a typical American portfolio is heavily concentrated in these, together with the SaaS/pandemic stocks, the losses from these would be greater than the combined losses from the Chinese holdings, likely occupying a small proportion of the portfolio. For instance, if AMZN, MSFT, FB, NFLX, and TSLA made up 80% of a $100,000 investment portfolio, a 10% decline would mean a loss of $8,000. BABA at 5% of the same portfolio would be a loss of $5,000, assuming BABA goes to zero. As a matter of fact, BABA is not delisted and is not worthless but the five mentioned American giant stocks have all declined more than 10% at several points this year.

Based on the following chart, BABA stock appreciated each time there was a major reduction in the low end of the price target by Wall Street. This happened in January 2021, May 2021, July 2021, and October 2021. Last week’s bounce following a steep downward revision continued this phenomenon.

On the recommendations by analysts, while bears may point to the fresh Strong Sell in March for the first time since July 2019, it should be noted that there are two new Strong Buy from January, despite the gloomy backdrop.

BABA is far from a SWAN stock and it may be cliché to say sentiment rules for now. Nonetheless, in investing, the adage that “valuation doesn’t matter until it does” applies to growth stocks on their way up and should also apply to BABA on its way down. Mere words had suppressed BABA stock over the past year. In a reversal, an official statement now appeared to have tremendous upside power on BABA.

As we head into April when fund managers need to report changes in their holdings, we could read about many of them flaunting how they courageously plowed into BABA at the bottom, when blood was on the street. This would then encourage more investors to join in the proverbial party and the positive momentum could snowball, particularly if meme traders also start boasting about their bravery trading BABA. Further upside could be magnified by short-covering along the way up.

The massive rebound last week is likely to have left a deep psychological barrier preventing BABA shareholders from panic selling again, at least in the near future. Just imagine, those who sold as BABA broke the $100 mark, they would be kicking themselves all this weekend. It would take higher prices for BABA shareholders to part with a stock now seemingly finding favor with investors again. Investors have no lack of reasons to avoid buying BABA at sub-$100. At above $200, non-shareholders would be fighting fear-of-missing-out [FOMO].