The market has not yet experienced the “roadrunner moment” when it realises there’s no longer anything holding it up. However, investors have certainly been evaluating their portfolios in the event the market’s twin supportive arches of short memories and cheap money disappear.
While the S&P 500 is nowhere near correction territory, far greater damage has been inflicted within the energy sector, where prices are down 13.7% over the last 30 days (the U.S. market is down 6.9%). Many technology stocks and other high-expectation companies, such as Tesla, are seeing significant volatility. Muscle memory from recent years has been to buy these dips – so we thought we would examine one of the market darlings floating on a cloud of positive sentiment, but where traditional valuation ratios indicate that investors are assuming perfect, risk free execution.
Alibaba Group Holding Ltd. (BABA.N), China’s mega e-commerce player, is a recent market entrant and one that currently carries seven buy recommendations and two holds. The company is the fourth-largest technology stock on the U.S. market, ranked by market capitalization, and the 11th largest overall.
The stock has plenty going for it, in many ways reminiscent of Google with a seriously impressive amount of free cash flow, as well as margins about 10x the industry average. The income breakdown waterfall (below) clearly calls out the low levels of cost associated with each dollar (or renminbi) of revenue.
Source: Thomson Reuters Eikon
Bright earnings outlook
The EQ score (below) is also a strong 97, driven by both cash flow and operating efficiency. Note there is no accruals score at this point; that will likely change when the company files its quarterly results.
Source: Thomson Reuters Eikon
Overvalued?
When you add together the words “Internet,” “China,” “social media” and “consumer,” you’re always bound to get breathless reports about the scale of the opportunity and a company’s unique position. We grant you that Alibaba does sit at the nexus of both advertising and e-commerce, however the current valuation of $84.95 is already implying 21.8% EPS growth each year for the next 10 years (30.1% over the next five). That’s the growth required just to support the current valuation.
In order to be bullish, one requires a belief that the market is under-appreciating the opportunity. Given that technology analysts are all basically bullish, it’s hard to see that as likely. Alibaba has a short interest score of 1, which would normally indicate a massive amount of institutional short positions. However, the Short Interest model for IPOs assumes that institutional ownership starts off at zero, so even a small amount of short interest affects the score. Alibaba has 0.8% of shares short but, of course, this number bears watching.
The company continues to see increases in sellside revenue forecasts, but already there are analyst downgrades (just to hold, of course), so while the revenue component of the Analyst Revisions Model is an impressive 97, the recommendations score is at the other end of the spectrum, with a score of 3. Essentially the company is doing well, and revenue estimates are climbing, but the share price has moved ahead too fast, and some are starting to sense that the valuation can no longer justify a buy.
Source: Thomson Reuters Eikon
What’s perfection?
If you watched the Internet bubble from behind a trading screen, it’s easy to remember the slow-motion train wreck that unfolded when greed turned to fear. Whether you want to look at bond yields, central bank balance sheets or any of the truly frightening indicators (like the return of covenant-lite bonds and enormous M&A deals) it’s easy to want to stick your head in the sand.
Great stock, structural growth, a mix of eBay, Amazon, Paypal and Google — all the right buzzwords, yet Alibaba stock is priced for perfection. Does that really exist?
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