Can Investors Finally Trust the Recovery in Alibaba Stock?

Key Points

• Alibaba stock has risen by more than 110% so far this year.

• It trades at a low valuation despite the run-up in the stock price.

• Investors still have good reason to be cautious.

• 10 stocks we like better than Alibaba Group ›

Alibaba Group (NYSE: BABA) has long disappointed investors since the launch of the stock in 2014. Amid political risks, high-profile U.S. investors were initially drawn by its cheap valuation and market leadership, but beginning in late 2020, Alibaba began to sell off, mostly due to the political risks.

However, the stock has risen more than 110% since the beginning of the year as decisions by the company and the Chinese government won the confidence of investors such as David Tepper, creator of the hedge fund Appaloosa Management, and ARK Invest's Cathie Wood. With the growing faith in Alibaba, should investors follow these high-profile investors or stay on the sidelines?

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Image source: Alibaba.

The state of Alibaba

Investors have often billed Alibaba as the "Amazon of China." It is the leading online retailer in the People's Republic, though the company also invests in artificial intelligence (AI) and supports ventures outside of e-commerce such as Alibaba Cloud and fintech services through Alipay.

The majority of its revenue comes from the Alibaba China e-commerce group. Nonetheless, much of the recent interest in the stock comes from the company's AI efforts.

Over the next three years, it plans to invest around $53 billion in the cloud and AI. The company also works with Nvidia on robotics and self-driving cars in addition to releasing a large language model.

And conditions appear to have improved on the political front. Jack Ma, who lowered his profile after criticizing the Chinese government earlier in the decade, has smoothed out relations with President Xi Jinping. This has helped allow him to return to the company, a move that should reassure investors.

Investors could also feel emboldened by its extremely low earnings multiple. Although valuations have risen along with the stock price, Alibaba's 21 price-to-earnings ratio (P/E) compares favorably to Amazon (34 times earnings) and Southeast Asia-based Sea Limited (91).

Why investors might turn cautious

Still, investors need to remember that China is under the same leadership, meaning they have to keep a wary eye on its political situation. Even though they might feel more comfortable with the risks of owning Alibaba, they should also remember that a delisting of the American depositary receipt (ADR) was a serious threat in 2022. Unfortunately for Alibaba bulls, the Securities and Exchange Commission now faces renewed pressure from lawmakers to delist it, pointing to a continued lack of confidence.

Moreover, remember that Charlie Munger, the vice chairman of Berkshire Hathaway, was an investor. However, he later called it "one of the worst mistakes I ever made" and began trimming his position when he assessed the political risks. He was a net seller of Alibaba at the time of his passing in November 2023.

Furthermore, the 20%+ revenue growth of the previous decade seems to be over. In the quarter ending in June, revenue of just under $35 billion rose by only 2% yearly. This included a 10% annual increase in the Alibaba China e-commerce group and a 26% rise in the Cloud Intelligence Group. Still, the combined 28% yearly revenue decline in its smaller businesses negated almost all of the revenue growth.

The company's profit picture is also deceptive. Over the same period, net income surged 76% higher to $5.9 billion. Still, mark-to-market gains in equity investments fueled most of that gain, and income from operations fell by 3% over time.

Investors should also remember the 24% increase in income from operations in the last fiscal year, indicating that the previous quarter's performance is an anomaly. Nonetheless, with revenue rising by only 6% over that same period, investors should probably resign themselves to slowing growth.

Should you trust the recovery in Alibaba stock?

Ultimately, whether you trust the recovery in Alibaba stock should depend on risk tolerance. Parts of the business continue to grow rapidly, and the return of Jack Ma and the cooling political tensions have likely emboldened some high-profile investors to buy the stock. In that sense, the company's improved outlook could justify adding a small position if your risk tolerance allows.

However, amid the still-low P/E, overall financial growth has slowed dramatically. And even if it emerges as a major AI player, political tensions and worries about Alibaba remain, possibly putting the stock at risk again. Thus, such dangers should call for either caution or avoidance regardless of your risk tolerance.

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Will Healy has positions in Sea Limited. The Motley Fool has positions in and recommends Amazon, Nvidia, and Sea Limited. The Motley Fool recommends Alibaba Group. The Motley Fool has a disclosure policy.