Lifestyle & Entertainment

4 Reasons Why I Won’t Be Investing in Alibaba Anytime Soon

Credit: Andrew Burton/Getty Images

By Adam Wong, chief editor of The Fifth Person

With all the ensuing hype about Alibaba’s historic IPO, it’s easy to get swept away amid the euphoria and jump onto the Alibaba bandwagon with the stock seemingly headed for the stratosphere.

There are good reasons why there’s been so much interest in Alibaba (e.g. the company dominates a whopping 80% of Chinese e-commerce and already handles more e-commerce transactions than Amazon and eBay combined), but even though I’m ecstatic about the success of its IPO which meant my stake in Yahoo got boosted along, there are a few reasons why I won’t be investing in Alibaba anytime soon.

#1 Valuation

Alibaba debuted at $68 a share and promptly surged 38% to close at $93.89 on its first day of trading. The stock has since come down a notch over the last couple of days, but at current price levels Alibaba is valued at roughly 57 times its earnings in the fiscal year ended in March.

That’s well above the S&P 500 P/E of 19.68. In comparison with its tech peers, eBay’s and Google’s P/E is 22 and 29 respectively.

On the other hand, Facebook trades at a P/E of 85 while Amazon, the US company most investors compare Alibaba to, trades at an outlandish P/E of 850!

Depending on your point of view, Alibaba could be cheap looking at the rich valuations Facebook and Amazon fetch or overvalued if you consider that 57 times earnings is too high even for a high-growth company like Alibaba.

Which brings to the next point: How sustainable is Alibaba’s growth?

#2 Growth

By all accounts, Alibaba’s growth has been phenomenal. Revenue growth in the first and second quarter this year grew 38% and 46% year-on-year respectively. For a large company (remember, Alibaba already dominates 80% of China’s e-commerce), that’s hugely impressive.

However, how long can Alibaba sustain growth rates at this level? The larger they grow, the harder it is to sustain breakneck growth like this and the company already handles more volume of merchandise than Amazon and eBay combined.

Using the PEG ratio, if you buy a stock at 57 times earnings, you expect growth to be at least 57% a year. Can Alibaba grow at those rates for the next few years to come? It’s anyone’s guess.

#3 No Public Track Record

When a company decides to go public, it is required to publicly disclose financial and business information. Investors use this information to decide whether a company is a worthwhile investment or not. A company with a long track record of strong financial and business performance is more attractive to investors and vice versa.

Like all newly-listed stocks, Alibaba has no public financial track record to speak of and will need a few years to build this up.

#4 Ownership Structure

When you purchase a share of Alibaba on the NYSE, you aren’t actually buying a share of Alibaba. Because of Chinese law forbidding foreign ownership in Chinese assets, Alibaba is using something called a “variable interest entity structure” to circumvent this rule.

When you buy a Alibaba stock, what you’re actually buying is a stake in a Cayman Islands-registered entity. This entity has contractual rights to the profits from Alibaba’s Chinese assets but will not actually own them.

Actual ownership and control of Alibaba remains with Jack Ma and his partners. You have no actual ownership of assets or any voting rights when it comes to Alibaba proper. While this doesn’t suggest that Jack Ma is planning anything untoward, you still need to have a huge amount of trust in him if you plan to invest a substantial amount in Alibaba stock.

Conclusion

Of course, Alibaba stock could continue to go up and up and up over the next few weeks and months ahead and I could miss out on a potentially huge return in the process. But even if the champagne continues to flow for Alibaba and its investors, for the reasons listed above, I won’t be joining the party anytime soon.

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ABOUT THE AUTHOR

Adam Wong is the chief editor of The Fifth Person and was featured on 938LIVE as a guest expert on MoneyWise. He is also the author of the national bestseller Lucky Bastard! which made the Sunday Times Top 10 Bestseller’s List in 2009 and Value Investing Made Easy, which made the Kinokuniya Business Bestseller’s List in 2013. An avid investor himself, Adam shares his personal thoughts and opinions as he journals his investing journey online. If you’re interested to learn more about stock investing, you can join The Fifth Person Newsletter and receive free weekly insights on how you can generate higher returns and dividend income from the stock market.

* The opinions expressed in this post are those of the author and do not necessarily represent the views of Business Insider.