Alibaba Stock: FOMO Is No Reason To Buy (NYSE:BABA)

Alibaba (NYSE:BABA) stock rallied 7.5% Thursday morning as a tame U.S. inflation report sent tech stocks soaring. It was the stock’s best rally since the Chinese government ordered state banks to start buying stocks. This year, the government has been attempting to stimulate the economy with mixed results. Asset purchases and other stimulative measures have been implemented, but zero-COVID has prevailed as the most dominant factor.

It’s interesting, then, that Alibaba actually rallied more than the average U.S. tech stock on Thursday. By 12 PM Eastern, the NASDAQ was up 6.25%; BABA was 1.25% ahead. There weren’t any known catalysts for Chinese stocks on Thursday, but American investors may have bought anticipating easier monetary policy. A significant percentage of the money invested in Chinese stocks is from American investors, and the treasury yield is their primary “opportunity cost.” Perhaps the simple fact of how cheap BABA has gotten combined with the expectation of a Fed pivot got investors buying.

Nevertheless, there are many potential catalysts for Alibaba in the future, including:

• Earnings. Alibaba will report its next earnings on November 17, and will likely benefit from accelerating Chinese GDP growth.

• Audit reviews. U.S. auditors recently went to Hong Kong to review Alibaba’s audit documents. We won’t know their opinion until December, but it is known that they concluded their review early, which some are taking as a good sign.

• Stock Connect inclusions. Alibaba will soon be added to Stock Connect, which may increase buying from Chinese retail investors-especially in light of the fact that Chinese real estate is no longer the sure bet it once was.

So, we’ve got many factors that could take Alibaba’s stock higher. As we saw today, lower U.S. inflation is enough to trigger a large, market-beating rally in BABA. Furthermore, Alibaba’s market capitalization is tiny compared to the company’s book value and earnings potential, so it shouldn’t be hard to come up with enough money to move the price a lot. The potential is there.

With that said, Alibaba is no stock to “FOMO” into. The acronym “FOMO” means “fear of missing out”–it refers to the tendency of investors to buy assets after huge rallies. Alibaba has treated investors to many big rallies this year, including one in which it gained 32% in a single day. Still, the volatility has been extreme. I’ve seen people on Fintwit (financial Twitter) and elsewhere buy the stock on rips only to panic sell later. After seeing a 10% rally a few weeks ago, I sent out a tweet telling people not to buy Alibaba unless their risk tolerance was very high, as the stock isn’t for the faint of heart.

I posted the Tweet on a day when BABA rallied. It was a good day, but I felt it was important to discourage risk-averse, short-term investors from buying just because the stock price went up. My overall opinion on Alibaba stock is bullish (hence the buy rating), but I believe there are segments of the investor public for whom it is unsuitable. In this article, I will explore why Alibaba stock is a buy for an investor identical to me in terms of risk tolerance and time horizon, but not for short-term oriented investors.

Who Should Invest in BABA?

If you’re going to invest in Alibaba stock, you need high risk tolerance. The reason is that the stock is subject to many risks, mainly political risks, and is likely to inspire panic selling in those who struggle with volatility.

The risks that Alibaba is subject to include:

• Regulatory risk. China did a regulatory crackdown in 2021 that ended with BABA taking a $2.8 billion fine. China’s government signaled this year that the crackdown was over, but there’s always the potential for such things to happen in the future.

• Zero COVID. China still follows a zero-COVID policy, which means lockdowns can occur in response to very small numbers of cases. This can depress corporate earnings as it limits people’s ability to work outside the home and make money.

• Delisting. The U.S. recently added Alibaba to the list of companies under suspicion under the Holding Foreign Companies Accountable Act (HFCAA), which threatens to delist Chinese companies not complying with U.S. audit requirements. If Alibaba passes the audit review, then delisting won’t happen, but on the flipside, if it fails, then delisting becomes more likely than ever.

These are significant risks. In fact, they are big enough that extremely risk-averse investors probably shouldn’t hold BABA at all. If large dips scare you, you may feel compelled to panic sell BABA, because there are enough risk factors at play that Alibaba can tank significantly when they rear their ugly heads. With that out of the way, let’s look into the opportunity that is present here for investors with high risk tolerance.

Alibaba: What’s the Opportunity?

The opportunity in Alibaba stock rests on two main factors:

1. Competitive position.

2. Valuation.

I’ll take a look at each of these factors in the sections below.

Competitive Position

Alibaba enjoys a strong competitive position in Chinese e-commerce. It has a 47% market share, which is way ahead of its main competitor, JD.com (JD). Alibaba’s advantages over its competitors include brand recognition, high margins, and operational diversification. If you look at JD, you’ll see that it actually does more in revenue than BABA does. BABA’s high market share is its share of profit: it earns vastly higher profits than JD does because it doesn’t hold inventory. Its e-commerce revenue primarily comes from ads placed on its platform by third-party vendors, it does not assume the costs of holding vast quantities of inventory itself. This high-margin model leaves Alibaba with plenty of money to invest in other segments, such as the cloud, which grew 10% last quarter and achieved positive EBITA profits. In addition to a growing cloud business, Alibaba also has numerous investments in companies like Alipay, Sun Art, and others. This was all made possible by BABA’s high margins, which its competitors lack.

Now, Alibaba’s competitive position has faced some setbacks in recent years. China’s 2021 tech crackdown forced the company to end its “choose one of two” policy and support Tencent’s (OTCPK:TCEHY) WeChat Payments App. Nevertheless, it is pretty strong.

Valuation

Next up, we have Alibaba’s valuation. According to Seeking Alpha Quant, BABA trades at:

• 8.8 times adjusted earnings.

• 29 times GAAP earnings.

• 1.37 times sales.

• 1.2 times book value.

• 8 times operating cash flow.

Apart from the GAAP earnings, these are all rock-bottom multiples. If it falls another 17%, then BABA is trading for less than the value of its assets, net of debt.

Alibaba also comes out looking pretty good in a discounted cash flow model. According to Seeking Alpha Quant, BABA had $4.34 in free cash flow per share in the trailing 12-month period. If you simply discount that at 4.12% (the current treasury yield), you get a terminal value estimate of $105, higher than the current stock price. If you discount it at 6%, you get to $72.3, which is still a small amount of upside. If you assume just modest 5% annual growth for five years, then you get a $132 target price at a 4.12% discount rate and $90 at a 6% discount rate. So, Alibaba does not need to grow very much, if at all, to rise from here.

The Bottom Line

The bottom line on Alibaba is that it’s a significant opportunity, but not one for the faint of heart. The stock is dirt cheap and still modestly growing its revenue over a 12-month period, but there are many risks that could affect the stock price.

What should an investor do here?

I’d recommend looking at your own investing track record and deciding based on that. If you have a long history of sitting tight, buying on weakness, and staying calm in the face of volatility, you may be able to benefit from owning Alibaba stock. In the long run, the company simply needs to thwart a few risk factors in order to rise, it does not even require growth to be worth buying at this point.

On the other hand, if you’re very short-term oriented, or have low risk tolerance, Alibaba may not be the play for you. Retirees living on fixed incomes, in particular, may be better off staying away. Alibaba does not pay a dividend, and it is subject to extreme volatility. This isn’t exactly the kind of stock you buy for regular cash flows.

Investors who are worried about the volatility of BABA stock may want to consider treasuries as an alternative. The volatility being observed in Alibaba stock is par for the course for equities. This year, we’ve seen U.S. tech stocks fall 80%, we’ve seen crypto exchanges go bust, and we’ve seen European banks issue Junk Bonds. In contrast to this are treasuries, which provide a nearly risk-free return backed by the government. They are by far the best assets for risk-averse, short-term investors to hold.