Summary
My investment journey with Alibaba began post-Ant Group IPO suspension amidst a selloff when I started acquiring shares with high conviction.
Three core principles developed during this four-year-long period, which became an integral part of my common-sense-based investing style.
It helped me recognize that Alibaba was heavily undervalued, while Wall Street was calling China "uninvestable".
The company has a scale, a moat, solid fundamentals, a substantial cash position compared to its debt, and keeps growing sales, which almost doubled since 2020.
Alibaba is a wonderful business, and I saw it a long time ago. Yet, being right in investing is not enough. You have to be right at the right time.
Btw, I recently found an awesome trading tool, Tiger CBA! You can trade immediately without upfront capital, just settle gains/losses later, and enjoy up to $20K trading limit with 7 days interest-free and 60 days commission-free trades. It's perfect for maximizing capital utilization and capturing market opportunities. If you're looking to trade more flexibly, definitely give it a shot, click to learn more, hope this helps.
On November 19, 2020, it was just after the company's stock got punished for the unexpected Ant Group IPO suspension. Subsequent events only added fuel to the fire and scared investors away, causing a long-lasting stock selloff. It was also the time I started investing in Alibaba with high conviction. I believed it was undervalued, and it would soon pay off while I was considering US companies overvalued as the US markets were inching to new highs. Yet, I didn't know a few things about investing, which later became an integral part of my strategy:
No matter how confident you are about the business, you may be wrong.
Avoid going too heavy too fast in one position.
Have in mind a maximum amount invested in one business relative to the size of your total portfolio.
If I had been aware of these rules, how would I have played it? Would the investment in a great business also become a great investment? Right now, after the stock jumped almost 70% this year, is Alibaba still a good investment considering the risks?
To answer these questions, I'll reassess my Alibaba investment journey and use a discounted earnings model to determine if it's worth investing in the business today from the risk/reward perspective.
It can take a long time for the market to recognize the value of a business and to price it accordingly, which is another lesson I learned while investing in Alibaba. Fortunately, I never lost a penny on the stock.
I want to believe that I owe it to common sense, which I've always tried to apply in my life and in my investment decisions. It let me see a bigger picture, which I shared with the Seeking Alpha readers in the article titled Common Sense Investing In Alibaba from October 11, 2021. Alibaba was trading then at $169.61, substantially lower than where I initially rated it as Strong Buy. Yet, while the whole investment world was abandoning China, it never crossed my mind to sell my shares. I kept myself grounded in fundamentals, and although I don't consider myself a great investor, I feel these words from Christopher Davis apply:
A necessary characteristic of great investors is that they can't be overly influenced by what other people think.
I'm strongly convinced that Alibaba is a great business. Probably, it won't be a great investment for me. Although I think it'll give me decent returns, it could have been a home run buy. However, by not losing money on Alibaba, I can take a look back at the whole journey with no hard feelings and draw conclusions that will be invaluable in making future decisions.
You May Be Wrong
I agree with Peter Lynch, one of the greatest investors who averaged a 29.2% annual return between 1977 and 1990 and believed that an investor must own a business to understand it truly.
The best way to learn about a company is to own a few shares.
Purchasing the first shares of Alibaba in 2019 gave me exposure to the business. It helped me understand it better and motivated me to stay up-to-date with company news. By the time the Ant Group IPO was suspended, I knew Alibaba was a great business. When the stock price dropped in the Fall of 2020, I started aggressively acquiring shares.
It was already too late when I learned a valuable lesson from another famous investor, Guy Spier, who founded the Aquamarine Fund in 1997, which returned 9% CAGR between 1997 and 2023. He had a clear way to decide how much of a new stock to buy:
The happy number for me is a 5% position, and what's interesting about a 5% is that if 5% is halved, you've only lost 2.5% of your portfolio, which is very likely to be survivable.
Let's consider a theoretical portfolio of $95,000. Following Guy Spier's rule, I should have aimed for a $5,000 investment in Alibaba. Now, let's backtest it by assuming share purchases were made on the dates when I released the first three articles on the company, each with a Strong Buy rating.
A scenario of buying shares of Alibaba on dates when I released articles
The initial purchase would have had a roughly 1% weight on the portfolio of $95,000.
The second buy would have increased the total position to 14 shares at the cost basis of $2374.54, excluding fees. This amounts to nearly half of the intentional position of $5,000.
The last acquisition would have brought the position to $5,032.74, with an average price per share of $92.33.
At that moment, I would have been done with buying, knowing that even if the stock price halves to, even at that time, a ridiculous $34.01, it wouldn't have knocked me down. I would have also been aware that I could be wrong. However, if I hadn't been wrong, the money would have been made in the waiting, as Charlie Munger used to say:
The big money is not in the buying and the selling, but in the waiting.
More Common Sense
Continuous share buybacks have been the most common-sense bullish sign for me over the last four years. The high-scale repurchase program clearly indicated management's view that the business was undervalued. In August 2021, less than a year after the initial Ant Group-related sell-off, the company announced the largest repurchase program in its history.
We are increasing our share repurchase program from US$10 billion to US$15 billion, the largest share repurchase program in the Company’s history, because we are confident of our long-term growth prospects. Our net cash position remains strong and we have repurchased approximately US$3.7 billion of our ADSs since April 1, 2021.
Since the failed Ant Group IPO in 2020, I have read numerous analyses trying to prove that Alibaba trades at a discount. On the other hand, dozens of discussions have also shown that Alibaba's stock price collapse is justified and that there is little hope for a recovery. The most frequent arguments against Alibaba and China in general were:
antitrust fines that were supposed to destroy Alibaba;
the disappearance of Jack Ma, allegedly tied to a government investigation;
delisting of Chinese companies from US stock exchanges;
regulatory pressure, which was expected to continue into the undefined future;
e-commerce slowdown crippling Alibaba indefinitely,
VEI structure of the Chinese companies,
and the list goes on. According to Wall Street, China was "uninvestable". Suddenly, all these arguments don't matter anymore, thanks to AI.
Chart: Americans See China Increasingly Negative | Statista
Negative Views of China (Statista)
Putting all arguments aside, the company kept repurchasing its shares, amounting to $43.13 billion in buybacks over a four-year period. And after all that time, the company's value was $235.77 billion. That's a clear and strong vote of confidence from management and, to me, an indirect buy signal, especially when the stock price was in a downtrend.
Alibaba's Fair Value
Emerging global opportunities and Alibaba's pursuit of profit in various areas of technology may put the company at the forefront of innovation. The business has a scale, a moat, solid fundamentals, a substantial cash position compared to its debt, and keeps growing sales, which almost doubled since 2020.
The sentiment around China has shifted. The market forgot about all the uncertainties it used to describe as "systemic risks" to Alibaba's business. Now, everyone's excited about Alibaba's push into AI and cloud computing. This only confirms that the company adapts to the rapidly shifting economy and goes far beyond e-commerce. In my opinion, a great business with a promising outlook repurchasing its cheap stock at a fast pace is an interesting proposition. The last piece of the puzzle is determining the business's fair value.
The value of a business can be determined by the sum of all future earnings discounted to their present value. Valuing a company requires certain assumptions, which should be conservative and include a margin of safety. In order to obtain the value of Alibaba, two cases were considered, and the following estimates were used:
EPS growth will amount to 19.1% CAGR for the next five years and will halve (decrease by 1/3 in the best-case scenario) in the subsequent five years.
The terminal P/E (price-to-earnings) ratio is 15, as is the long-term market average. The best case assumes that the multiple will be 18.
The discount rate that determines the value of all future earnings is 10.0%. This rate matches the expected growth of a broad stock market index.
Alibaba DCF Valuation
Normal-Case Scenario (Author: Data - Seeking Alpha)
The normal case projects a rather conservative terminal P/E ratio at the end of the ten-year period. Growth numbers are realistic and should be met, especially during the AI race, in which Alibaba may be a main contender. These assumptions lead to an intrinsic value of $154.33 per share, 7.2% above today's stock price.
Alibaba DCF Valuation
Best-Case Scenario (Author: Data - Seeking Alpha)
The best-case scenario isn't based on exuberant assumptions. Yet it indicates that Alibaba's fair value is $193.71, suggesting the company is undervalued by 35.3%. The terminal multiple is reasonable, particularly for a company with a moat.
These are just assumptions and projections based on the current environment and analyst estimates supported by numbers from the past. They might not materialize, and it can turn out that the future holds something entirely different for the company and its investors. Based on these valuation scenarios, the business is no longer a screaming buy. The amazing 68.89% YTD run in stock price lowered the expected return. It's also the first time I've given Alibaba a Buy rating, breaking the four-year trike of assigning a Strong Buy to the company. Even if the calculated value is not 100% accurate and the company is fairly valued right now, it's still a wonderful business for a fair price.
It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
~ Charlie Munger, the former vice chairman of Berkshire Hathaway (BRK.A), (BRK.B)
Risks
Without question, the company has had four difficult years. The most recent rally doesn't mean that everything is over, and the future looks bright. Yet, Alibaba's investments give me confidence and reasons to expect a reacceleration of growth after solid but muted post-pandemic years.
There are hurdles ahead, like commerce saturation, competition, and regulatory pressures due to the size and complexity of Alibaba's empire. If anybody considered the Chinese government a threat to the company's operations, he should still see it as such. Just because the broadly reported crackdown on tech businesses isn't making the headlines, it doesn't mean that it can't resurface. The company is transparent about it:
Given the uncertainties relating to the interpretation and enforcement of PRC laws, rules and regulations, it is possible that our existing operations may be found not to be in full compliance with relevant laws and regulations in the future.
The VEI structure, which has been all over the news in recent years, is still there to limit foreign ownership. This means that investors don't own the actual shares of Alibaba. The Chinese government can cancel the contracts representing the shareholders' ownership between the offshore entity and Alibaba at any time. Yet, this risk has existed since Alibaba was listed on foreign stock exchanges.
Still, the diversification within Alibaba's business is a great weapon against risks related to its individual segments. If a certain area gets affected, there are multiple other revenue streams that can absorb a hit to one of the parts. The ongoing investments and partnerships suggest that Alibaba is pursuing new revenue streams in AI, cloud computing, chip manufacturing, and potentially smart cities, robotics, and more.
Conclusion
The Alibaba position has been an important lesson for me and another piece of the puzzle, allowing me to define my own investing principles. Whenever I make a buy order, I remember:
I may be wrong;
I start a position and keep adding to it slowly.
The contributions will continue until I reach a clearly defined amount relative to the size of my portfolio.
If I hadn't experienced the ride with the Alibaba investment, I would have had to learn the rules later. It might have been with much more money stuck in a business, or it could have been much more painful.
Seeing the company thrive in AI and cloud computing while its stock price is soaring gives me optimism. However, it also tells me that being right in investing is not enough. You have to be right at the right time. Otherwise, a great business won't be a great investment. Alibaba is a wonderful company that sells at fair value.
Comments