Despite being one of the most prominent Chinese technology names, investor sentiment and risk tolerance for Alibaba has faded dramatically. It’s been a volatile stock with an October 2020 high of $319 but today trades at around $72. So if I’d invested £10,000 in Alibaba stock five years ago, how much would my investment be worth today?

Not pretty

In dollar terms, Alibaba stock declined 59% over the last five years. Ouch! However, the pound has significantly weakened against the dollar in that time to increase the value of my hypothetical investment. Even with currency effects taken into account though, I’d only have £8,358.70 remaining of my £10,000 investment. I’d be down 16.41% after five years, excluding broker fees. Alibaba has never yielded a dividend that could have boosted my investment value. Below is a full breakdown.

The performance has been dismal. For context, an investment in the S&P 500 index would have returned 45% in the same period. That’s without taking into account currency fluctuations and dividend payouts. Despite Alibaba stock’s poor historic performance, should I invest in the Chinese multinational company today?

Do the fundamentals matter?

Alibaba is a company that has delivered revenue growth rates comparable to US tech giants Apple, Alphabet and Meta. Today, it looks cheap with a forward price-to-earnings ratio of just 9.28. It’s also China’s largest provider of public cloud services by revenue with plenty of room to grow. But its long-term performance could have very little to do with fundamentals and more to do with its numerous and complex challenges.

Firstly, Alibaba stock may be delisted from the New York Stock Exchange. Regulators from the US have long demanded complete access to audit working papers of New York-listed Chinese companies, including Alibaba. If this isn’t resolved, a delisting is a possibility. While this wouldn’t directly affect shareholders’ rights or claims on Alibaba, the holdings would be harder to sell and the share price could plummet. 

Secondly, Alibaba’s revenue is being hampered by Beijing’s strict zero-Covid policy. In the second quarter of the year, Alibaba posted its first ever flat year-on-year quarterly revenue growth. There are no signs of this policy easing so future growth is very unpredictable.

Finally, China-US relations continue to worsen. The US government’s crackdown on chip exports to Chinese companies will have put further pressure on Alibaba’s growth. It’s hard to see these relations improving any time soon.

This unpredictability makes it incredibly difficult to value the company. Without these geopolitical and regulatory headwinds, Alibaba stock would look like a bargain. However, I don’t feel comfortable investing in it today. Contrarian investments can deliver great returns for brave investors, but for now, I’m sticking to safer investments elsewhere.

The decline of Alibaba

In October 2020, Alibaba had a market capitalisation of $800bn, and many believed that it would be the next company to reach the $1trn valuation mark. However, from this point, everything started to go downhill. 

For one, China started to crack down on tech giants, handing out extremely large fines for anti-competitive behaviour. For example, in the quarter ending 31 March 2021, it was announced that Alibaba had been given a $2.8bn fine under the anti-monopoly act. This was the largest fine ever handed out by the Chinese government. It also represented around 4% of the company’s domestic annual sales. 

Recently, the group has also seen slowing growth, partly due to the macroeconomic environment. This includes large inflationary pressures, which may reduce consumer spending on discretionary goods. As such, alongside other growth stocks, Alibaba has dipped to a market cap of ‘only’ $300bn. Over the past year, it has fallen 50%. 

What are the positives? 

Despite these recent fears, I can still see a large amount of long-term potential with Alibaba. For example, despite the macroeconomic uncertainties, revenue climbed 9% year on year. Although this is far slower growth than previously, it is still encouraging to see some sort of growth. 

Further, China has recently signalled an easing of its tech crackdown, after Chinese officials met with some of the country’s top technology executives. Chinese Vice-Premier Liu He also signalled that these companies would receive more support from the government. Some investors have argued that this may indicate the start of a bull market for Chinese tech stocks.

Finally, I feel that the group’s international operations could drive future growth for the company. For example, in 2018, Alibaba acquired Daraz, which has expanded Alibaba’s reach into Pakistan, Bangladesh, Sri Lanka, and Nepal. The company also owns Lazada, which operates in south-east Asia, and Trendyol in Turkey. The CEO of Alibaba, Daniel Zhang, believes that these international businesses have “huge potential”. This is a very encouraging sign. 

What’s next for this growth stock?

There are many challenges facing Alibaba, yet I remain confident about the company’s long-term prospects. Revenue in the Asian e-commerce market is expected to reach over $2.6trn in 2025, up from around $2trn this year. Alibaba also trades at a price-to-earnings ratio of around 14. This is very low for a growth stock. Therefore, this is a company I would be very willing to buy and hold for the next five years. 

1. Support overseas stock listings
2. Stabilise capital markets
3. Resolve risks around property developers
4. Speed up the process of regulating big tech companies

In doing so, the Chinese authorities have addressed three of the biggest risks that investors who have exposure to Chinese stocks face. Some — most notably Charlie Munger — were less worried about these than others. But the market’s response to today’s announcement indicates that investors are generally feeling more comfortable about the risks. Let’s take Alibaba as an illustration of all three.

VIE structure

Investors who buy the NYSE-listed entity with the ticker symbol ‘BABA’ aren’t buying shares in Alibaba. Instead, they’re buying shares in a ‘variable interest entity’ (VIE) that is a separate company that has contracts that give it a claim on Alibaba’s assets and earnings. Why does such a thing exist? Because under Chinese law, it’s illegal for Alibaba to have non-Chinese shareholders. The VIE structure is intended to allow foreign capital access to Chinese companies (albeit indirectly) and to allow Chinese companies access to foreign capital.

The risk comes from the fact that a VIE is designed to circumvent Chinese law. As such, its contracts — which are the only things it has of any value or that connect it in any way to Alibaba, the company — might not be enforceable. That would mean that shares in the VIE could be worthless if the Chinese authorities ever decided to clamp down on VIE structures. Today’s announcement that China intends to support overseas stock listings goes some way towards limiting concerns about this possibility.

Delisting

A second source of concern comes from the possibility of the US delisting Chinese stocks from the NYSE. The Holding Foreign Companies Accountable Act of 2020 requires Alibaba to submit audit documents in support of its financial statements. Otherwise, it can be delisted from the US exchanges. The trouble is, Chinese regulation prevents them from doing this. 

This concern is assuaged somewhat by the announcement that the Chinese authorities are prepared to support overseas stock listings. The details are still to be worked out, but the idea that there might be the will to work towards resolving the impasse is encouraging for investors.

Regulation

The third major risk associated with Alibaba is the threat of government regulation. Alibaba has more history than most with this threat, after it picked up a record fine last year for abusing its dominant market position. But it’s far from unique. Various other Chinese tech companies have also faced similar sanctions.

The risk of further interventions against Alibaba and China’s other big technology firms has been a source of uncertainty around the stocks. Today’s announcement that the Chinese regulators intend to make things more transparent is positive news for investors.

NIO stock: growth in the EV market?

NIO managed to climb in 2020 as demand for electric vehicles soared. This has allowed the firm to raise both delivery volumes and revenues. For example, in the third quarter of 2021, it saw revenues of over $1.5bn, a 116% year-on-year increase. Total deliveries also managed to total 24,439, another 100% year-on-year rise. Clearly, this demonstrates that the firm is operating well. After the recent share price crash, with NIO down over 60% in a year, it also gives the EV maker a price-to-sales ratio of around just five, far lower than its previous valuations.

However, there are many risks that are outside of the company’s control. For instance, there’s that possibility that NIO could be delisted from the US, and this will prevent it from raising more money on the US market. It has started to trade on the Hong Kong market, a route which seems forced rather than desired. Indeed, the company chose a listing path that didn’t raise any new money.

There’s plenty of competition in the Chinese EV market too. For example, in February, NIO ranked eighth for EV vehicles sold there and this suggests that it may find it hard to reach profitability. As such, while I feel the current share price is tempting, there are too many risks for me. This is a Chinese share I’ll be avoiding for now.

Alibaba stock: a well-established Chinese share

Alibaba (NYSE: BABA) has also been crashing recently, as the worries surrounding the delisting issue continue. The firm has seen slowing growth, another factor that has led to its recent decline. In fact, Alibaba stock is also down 60% over the past year, currently priced at under $80.

But while the risks around investing in Chinese shares remain, Alibaba’s financials suggest to me that it’s far too cheap. In fact, it has not been this low since 2016, a time when revenues only totalled around $15bn. In the trailing 12 months, it has generated revenues of over $130bn. This shows that the current share price is out of touch with Alibaba’s performance, and fears around China may be overstated.

As Covid cases rise there, I also feel that this could benefit the e-commerce company. Therefore, if profits can continue to grow, it seems to me that the Alibaba share price should be able to recover. This means that I’m very tempted to disregard the risks of investing in Chinese shares and open a small position in Alibaba. In any case, I prefer Alibaba to NIO.

Shares in the Chinese e-commerce giant have come under pressure for several reasons. The decision by Chinese policymakers to start clamping down on high-flying technology groups sparked the sell-off. Since this threat emerged, investors have been struggling to digest other risks to the company’s growth potential.

These include everything from additional regulations, the trade war between China and the US, and competitive forces in the global technology market.

However, despite these challenges, the company remains one of the largest e-commerce groups in China. It is also investing heavily in new growth initiatives, such as cloud computing.

Considering these tailwinds, I have been trying to evaluate if it is worth adding the stock to my portfolio after recent declines.

Alibaba share price risks 

While the company might look cheap compared to its potential, the Alibaba share price is not a traditional investment. The stock is traded through what is known as a Variable Interest Entity (VIE).

This structure allows Western investors to own part of a Chinese business although they do not actually own a piece of the underlying business. Instead, they own part of a network of offshore entities, which have a claim on the underlying company’s profits.

The problem with the structure is that it is not legal. Nor is it technically illegal. It is a grey area. And this is another reason why the market has been avoiding the stock over the past 12 months. There is some concern that the structure could fall foul of regulations.

This is the primary reason why I have always stayed away from the Alibaba share price. If Chinese regulators wanted to cut the company off from New York, they could do so at a moment’s notice. While I think this is unlikely, it is a risk I need to consider before investing.

I have also been considering the general regulatory environment for the tech sector worldwide. This is shifting and technology companies are having to work to appease regulators. Ultimately, I believe this will lead to lower returns for investors.

Opportunities ahead 

That is not to say these companies have a bleak future. I believe businesses like Alibaba will be able to capitalise on the growing demand for e-commerce and e-commerce products worldwide. It already has the logistics to capitalise on this growth. Competitors may struggle to replicate this advantage.

What’s more, the business has a strong balance sheet and is generating vast amounts of cash. These resources can be used to further the company’s expansion and grip over its core markets.

Still, while I think the business does have some desirable qualities, I cannot get the regulatory threats out of my head. There is no telling how regulators in China and the US will react over the next 12-24 months. On that basis, even though the stock looks cheap compared to its past trading history, I am not in a rush to buy the shares.

I would rather sit on the sidelines and see how the regulatory environment evolves over the next couple of years. I do not think the stock will recover from its losses any time soon. 

Indeed, for the quarter ended September 2021, the company reported year-on-year revenue growth of 29%.

Booming market 

That is not all. As the group controls around 50% of the Chinese e-commerce market, it should be able to piggyback on the industry’s growth over the next five years. The Chinese e-commerce market is expected to grow at an annual growth rate of 12.4% over the next four years. 

Unfortunately, the situation is a little more complex than this. Suppose it was just a case of analysing the potential for growth in the Chinese e-commerce market over the next five to 10 years. In that case, I think investor sentiment towards the Alibaba share price would be significantly better than it is today. 

It seems as if there are a couple of other reasons why investors are avoiding the shares. The biggest appears to be the changing regulatory environment throughout China. The country’s “common prosperity” drive and the recent regulatory crackdown has rocked the region’s technology sector.

Alibaba has announced it will be investing $15.5bn to enhance common prosperity over the next four years. Put simply, this means the company will be giving away the money. 

Spending $15.5bn on government initiatives will almost certainly impact on the group’s growth. It is money the company cannot use to pursue its own ambitions. 

Alibaba share price risks

At this point, there is no telling if the government will demand yet more  from Alibaba. There is also no telling if government regulators will intensify their attack on technology enterprises like this one. In 2021, regulators slapped a $2.8bn fine on the business for anti-trust issues. And another penalty was issued earlier this year. 

These challenges illustrate why investors have been avoiding the Alibaba share price. While I believe this business is one of the best ways to invest in the growing Chinese e-commerce market, I am incredibly concerned about the issues outlined above.

If the company has to foot the bill for further fines and common prosperity initiatives, it will struggle to maintain its market share and capitalise on the wider market growth. 

And if the business loses market share over the next few years, the enterprise will be worth less in the future than it is today.

As such, it is too difficult for me to place a value on the Alibaba share price based on what I know right now. For that reason, I will continue avoiding the company, at least until there is some more clarity on regulators’ intentions. 

I should clarify that Munger bought the holding for the portfolio of Daily Journal Corporation. He is the chairman of the company and manages its extensive investment portfolio. 

As he has been buying the shares for the company rather than for his own account, I think this point is worth clarifying. In some respects, Munger is using other investors’ money as it is the group’s shareholders that ultimately own the Daily Journal’s portfolio. 

He has not said that he has bought the stock for his personal investment portfolio. Munger rarely comments on his investments, but we do know his most significant investment is Berkshire Hathaway. This holding accounts for the vast majority of his $2.4bn net worth. 

Still, after doubling the size of the Alibaba position in the Daily Journal’s portfolio, it is now the third-largest US equity position. I should also note that in the past 12 months, Munger has accumulated this position from scratch. In around a year, he spent $70m of the Daily Journal’s cash building the holding. 

Charlie Munger’s investments 

Considering Munger’s reputation and success as an investor, I like to keep an eye on his investments. Some could be a good fit for my portfolio. 

When it comes to Alibaba, I think the company has a lot of potential. Its position in the market suggests that it should be able to capitalise on the growth of the Chinese economy over the next couple of decades. Indeed, analysts expect the Chinese e-commerce market to grow at a compound annual rate of around 12% over the next five years. 

If Alibaba can ride this wave and increase its market exposure simultaneously, its sales growth could exceed this rate of expansion. The company also has a vast amount of consumer data that it can use to sell other products and services.

However, as I have noted before, I am worried about the company’s listing structure. The tug-of-war between US and Chinese regulators is also concerning. Regulatory actions could destabilise the group and ruin its growth potential. It is almost impossible to predict if regulators will move against the corporation and other listed Chinese businesses.

Index fund 

Considering these risks, I am not going to invest in the company. Nevertheless, I do own a Chinese equity market tracker fund. Alibaba is one of the key holdings in this fund. As such, I do have some exposure to the e-commerce retailer. 

So overall, while I am not following Charlie Munger into Alibaba, I am happy to have some exposure to China in my portfolio. I think the best strategy for me to do this is to use an index fund. This diversified approach should help spread the risk around individual opportunities. 

As a value investor, this performance has ignited my interest in the China-based, US-listed online giant. As such, I have been taking a closer look at the stock to see if it could be worth adding shares to my portfolio. 

Alibaba share price decline 

Whenever I come across a stock that looks cheap compared to its trading history, I try to understand why the market has turned its back on the enterprise before making any move. 

With Alibaba, it looks as if the market is worried about the tension between the US and China, as well as growing regulatory threats in China. 

Over the past two years, domestic regulators have been clamping down on companies that they believe have too much power. Regulators have also moved against individuals they believe hold too much power, including Alibaba’s founder, Jack Ma. 

If there is one thing the market hates more than anything else, it is uncertainty. Right now, there is a lot of that surrounding the business environment in China. It is impossible to tell where regulators will strike next. 

What’s more, there has been some speculation that growing friction between China and the US could lead the former to cancel the variable interest entity (VIE) structure Chinese companies like Alibaba have used to list in the US.

This structure is not technically legal, although it is also not technically illegal. As such, there will always be a threat that regulators could opt for the latter. If they do, it is impossible to say what impact this will have on the Alibaba share price. 

Business environment

These are the main reasons the market has been selling the stock over the past year. However, away from these headwinds, the corporation’s underlying fundamentals look incredibly attractive. Alibaba is the largest e-commerce enterprise in China, a booming market. For the quarter to the end of September, revenues jumped 30%. Last year, revenues grew 41%, underlining the scale of the company’s growth potential. 

Analysts expect the Chinese e-commerce market to grow at a compound annual rate of 12% over the next couple of years. Suppose Alibaba can ride this growth wave and continue to expand its presence across the country. In that case, I do not think it is unreasonable to say that the business can continue to report double-digit sales growth for the next few years. 

And if it can hit this target, the stock looks dirt cheap. It is currently selling at a price-to-earnings (P/E) multiple of 17. 

Still, despite the company’s potential and valuation, I am not interested in buying the shares for my portfolio. It is impossible to predict how Chinese regulators will act going forward, so I would rather invest my money in a different opportunity.

Friction with local authorities

Firstly, it’s important to understand why the shares have fallen so much this year. They trade in the US but are also listed in Hong Kong. 

The business has come under scrutiny recently due to tensions rising between China and the global companies that hail from the country. For example, in recent weeks a Chinese company named Didi has decided to delist from the US and will list in Hong Kong instead. Many see this as a reaction to pressure from the Chinese Government.

The shares have fallen showing that even the shining star of Chinese e-commerce isn’t immune to the pressure. Co-founder Jack Ma even dropped out of sight for a couple of months at the turn of this year. This didn’t do the public image of the company any good. As for the business, it was fined $2.8bn by the Chinese market regulator for monopolistic abuse in Q1. This was quite a large amount, 4% of the company’s 2019 domestic revenue. 

The bottom line here is that investors are clearly nervous about the relationship between Alibaba and the Chinese Government, as well as the influence being exerted.

Strong financials for the shares

If I strip out the noise around the authorities, there are many reasons to like the shares based on financial performance. Last month, quarterly results showed a revenue increase of 29% year-on-year. Although adjusted EBITA actually fell by 32%, this was largely due to investments made in key businesses within the group. Therefore, I’m not too concerned about this. If anything, the investments should help to grow overall profitability in years to come.

Alibaba is also growing the active customer base. This is key as the ecosystem that the business is trying to push needs a high volume of clients to make it successful. In the results, it noted an annual active customer base of 1.24bn, an increase of 62m from the previous quarter. The overall figure is impressive and will help to drive the business forward in 2022.

Overall, it’s a difficult call as to whether I should buy the shares now. They do look cheap, and I think the strong growth shown by the latest results isn’t reflected in the current share price. However, I’m very conscious of the influence that the Chinese Government has over the actions of the firm. If further measures are taken, such as restricting operations abroad, then I could easily see the share price slump further.

Therefore, as much as I like the business, I think it’s too much of a risk to buy shares at the moment.

While I can understand why the market has been selling the stock, I think current investor concerns overlook the group’s true potential. 

The outlook for Alibaba stock

As one of the largest e-commerce groups in China, Alibaba’s market opportunity is massive. And when I say massive, I mean genuinely massive. It is projected that by 2024, e-commerce sales in China will be worth more than $3.3trn a year. 

And that leading position means it has around 51% of the Chinese market, although this share has been under pressure in recent years. Some estimates suggest it could fall below 50% for the first time next year. 

While this is disappointing, it needs to be put into perspective. Amazon‘s share of the US e-commerce market is around the same, but this company has a market capitalisation of $1.7trn. Alibaba’s market value is $300bn. The size of the US e-commerce market is less than $1trn. 

So Amazon has the same share of a smaller market and is worth five times more. This does not make much sense to me. Even though it is losing market share, I think Alibaba deserves a higher valuation than Amazon, considering its position in a much bigger market. 

That said, Alibaba does have a smaller global footprint. Its presence outside of China is almost non-existent. What’s more, the American retailer is more diversified. Its cloud computing and marketing businesses now provide more profit than the retail side of the company. 

China threats 

Alibaba does have a level of diversification away from the retail side of the business, but, again, this is mostly concentrated in China. More importantly, Chinese regulators do not want companies like Alibaba to expand too much overseas. They argue that this could jeopardise national security if overseas regulators demand access to valuable data resources. 

The risk that Chinese regulators will clamp down on Alibaba is one of the primary reasons why the stock has fallen so far, so fast, in recent weeks. The clampdown has already claimed one company, ride-sharing group DiDi, which has been asked to delist from the New York Stock Exchange and relist in Hong Kong. 

This is a significant risk, and it is impossible for me to quantify. I am not going to pretend to know what is on the mind of Chinese regulators. As such, I cannot say with any certainty if they will decide to clamp down on the business or not. 

Considering this risk and the market opportunity available to the group, I would be happy to buy the stock for my portfolio, but only as a small speculative position. I think the company’s potential is clear, but so are the risks.