Stick With Red-Hot Alibaba Stock

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Shares of Chinese technology giant Alibaba (NYSE:BABA) finally took out the $200 level in late November 2019 amid easing U.S.-China trade tensions. That brings the 2019 gain of Alibaba stock to nearly 50%. It also puts BABA stock at its all-time highs.

This Long-Term Bull Run on Alibaba Stock Has Plenty of Steam Left

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Up 50% over the past 11-12 months? Trading at all time highs? I wouldn’t blame anyone for thinking that it’s time for red-hot Alibaba stock to take a breather.

But BABA stock won’t do that. Instead, Alibaba stock looks optimally positioned to keep running higher deep into 2020, driven by improving macro trends(including easing U.S.-China trade tensions and improving China economic momentum) and rebounding company-specific trends (stabilizing revenue growth rates, improving margins, etc). Also of note, BABA stock still trades at a discounted valuation relative to its long-term growth potential.

I don’t expect the Street to start worrying about the valuation of Alibaba stock until the shares reach $250, nearly 25% above where they are trading hands today. Thus, as long as the company’s fundamental and optical drivers remain favorable, I say stick with the rally of red-hot Alibaba stock.

All of BABA’s Trends Are Improving

All of the important trends surrounding Alibaba stock are improving heading into 2020.

On the macro side, U.S.-China trade tensions are easing, and that easing is sparking a rebound of China’s economy. Specifically, the OECD’s Composite Leading Indicator (CLI) reading for China has improved month-over-month for eight straight months. And for the past two months,  the CLI has grown year-over-year for the first time since early 2018. Also, China’s Manufacturing PMI rose sharply in November, exceeding 50 for the first time since April. And retail sales trends have stabilized over the past few months, with the e-commerce sector enjoying sustained, strong growth.

Overall, China’s economy is showing signs of life again, thanks to easing U.S.-China trade tensions. Those trade tensions should continue to ease in 2020, as China doesn’t want to upset its economic rebound while U.S. President Donald Trump doesn’t want to upset the apple cart in an election year. Continued trade war deescalation should propel a sustained rebound of China’s economy throughout 2020.

On the company-specific side, Alibaba’s revenue growth rates are stabilizing and its profit margins are improving. Throughout fiscal 2019, Alibaba Group was characterized by rapidly slowing revenue growth rates and significantly falling profit margins. That was caused by a slowdown of the Chinese economy and huge, growth-related investments by Alibaba. Now, though, China’s economy is rebounding, and Alibaba’s large investments have phased out. Its revenue growth rates have stabilized, while its profit margins have steadily rebounded.

Those improvements should persist. On the revenue front, a sustained Chinese economic rebound should trigger strong growth across Alibaba’s business. At the same time, there are no big investments on the horizon which should weigh on BABA’s margins, so its profitability should continue to climb.

Alibaba Stock Can Hit $250

Investors won’t  be concerned about the valuation of Alibaba stock until it hits $250, meaning that the shares have the potential to rise another 25% rather quickly.

Alibaba’s top line is increasing at an annual rate of 40% now. That growth will slow over the next few years for a few reasons. First, the law of large numbers and tougher comps will cause the growth to decelerate. Second, China’s e-commerce market, along with its digital ad and cloud markets are all expected to slow.

But, given that China’s internet penetration rate remains well below the average of developed economies, China’s digital economy appears to have a lot of room for further growth over the next few years. The international expansion efforts of Alibaba Group should also keep its growth rates elevated for a long time.

Thus, while Alibaba’s revenue growth rates will slow, they won’t slow by that much. Realistically, over the next few years, its top line  should grow about 20%.

Meanwhile, Alibaba’s net profit margins are about 25% today. They used to be 40%. Alibaba Group’s margins will never get back to 40%. That’s because, in order to power its big growth, Alibaba launched some lower-margin businesses, But those lower-margin businesses are becoming more profitable as they grow. As this trend persists, Alibaba’s profit margin could realistically rise to nearly 30%.

Assuming  roughly 20% revenue growth and slight margin expansion, Alibaba’s profits should rise at a healthy 20%-plus annual  pace. My modeling suggests that its fiscal 2026 profits will land somewhere around $20 per share. After incorporating a forward  price-earnings multiple of 20, which is average for the information technology sector and a 10% annual discount rate, I calculate a fiscal 2020 price target for Alibaba stock of nearly $250.

The Bottom Line on BABA Stock

Alibaba stock is a long-term winner that is getting its groove back. The company will maintain its groove in 2020 as U.S.-China trade tensions continue to ease. As the company continues to benefit from the positive trends I described above, Alibaba stock will remain on an upward march towards $250.

As of this writing, Luke Lango was long BABA. 

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