Deep Dive into BABA — Are These Shares Fairly Valued?

Internet Retail company Alibaba is standing out today, surging to $88.03 and marking a 10.2% change. In comparison the S&P 500 moved only 2.6%. BABA is -33.94% below its average analyst target price of $133.26, which implies there is more upside for the stock. As such, the average analyst rates it at buy. Over the last year, Alibaba has underperfomed the S&P 500 by 22.5%, moving -34.8%.

Alibaba Group Holding Limited, through its subsidiaries, provides technology infrastructure and marketing reach to help merchants, brands, retailers, and other businesses to engage with their users and customers in the People's Republic of China and internationally. The company is a consumer cyclical company, whose sales figures depend on discretionary income levels in its consumer base. For this reason, consumer cyclical companies have better sales and stock performance during periods of economic growth, when consumers have more of an incentive to spend their money on non-essential items.

Alibaba's trailing 12 month P/E ratio is 115.8, based on its trailing Eps of $0.76. The company has a forward P/E ratio of 10.3 according to its forward Eps of $8.51 -- which is an estimate of what its earnings will look like in the next quarter.

The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead). As of the third quarter of 2022, the consumer cyclical sector has an average P/E ratio of 24.11, and the average for the S&P 500 is 15.97.

BABA’s price to earnings ratio can be divided by its projected five-year growth rate, to give us the price to earnings, or PEG ratio. This allows us to put its earnings valuation in the context of its growth expectations which is useful because companies with low P/E ratios often have low growth, which means they actually do not present an attractive value.

When we perform the calculation for Alibaba, we obtain a PEG ratio of 217.78, which indicates that the company is overvalued compared to its growth prospects. The weakness with PEG ratios is that they rely on expected growth estimates, which of course may not turn out as expected.

To gauge the health of Alibaba's underlying business, let's look at gross profit margins, which are the company's revenue minus the cost of goods only. Analyzing gross profit margins gives us a good picture of the company's pure profit potential and pricing power in its market, unclouded by other factors. As such, it can provide insights into the company's competitive advantages -- or lack thereof.

BABA's average gross profit margins over the last four years are 42.3%, which indicate it has a potential competitive advantage in its market. These margins are declining based on their four year average gross profit growth rate of -6.9%.

Alibaba's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to the company's operating cash flows minus its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:

Date Reported Cash Flow from Operations ($) Capital expenditures ($) Free Cash Flow ($) YoY Growth (%)
2022-03-31 142,759,000,000.0 -53,309,000,000.0 89,450,000,000.0 -53.0
2021-03-31 231,786,000,000.0 -41,450,000,000.0 190,336,000,000.0 28.56
2020-03-31 180,607,000,000.0 -32,550,000,000.0 148,057,000,000.0 28.2
2019-03-31 150,975,000,000.0 -35,482,000,000.0 115,493,000,000.0 n/a
  • Average free cash flow: $135,834,000,000.00
  • Average free cash flown growth rate: 1.3 %
  • Coefficient of variability (lower numbers indicating more stability): 32.0 %

Free cash flow represents the amount of money that is available for reinvesting in the business, or for paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, BABA is in a position to do either — which can encourage more investors to place their capital in the company.

Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (market value divided by book value). The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method.

Alibaba's P/B ratio of 0.2 indicates that the market value of the company is less than the value of its assets -- a potential indicator of an undervalued stock. The average P/B ratio of the Consumer Cyclical sector was 3.11 as of the third quarter of 2022.

With an inflated P/E ratio, an exceptionally low P/B ratio, and a steady stream of strong cash flows with a flat trend, we can conclude that Alibaba is probably fairly valued at current prices. The stock presents poor growth indicators because of its consistently strong gross margins with a negative growth rate, and an inflated PEG ratio.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.