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Amazon may soon become the world’s largest company. Alibaba is often labeled the Amazon of China.
In the last year Alibaba shares have started to match the fantastic growth rates that we have seen in Amazon. With its comparatively lower earnings multiples, is Alibaba stock worth taking on any perceived extra risk?
Amazon.com, Inc. (NASDAQ: AMZN)
If considering Amazon as an investment I recommend you avoid two trains of thought that I often witness. I hear of many shareholders totally abandoning any valuation metrics with their decision to stay invested. Non holders sometimes give no consideration to investing in the stock due to the share price strength to date. I will attempt to avoid both biases which are irrational.
The moat and growth prospects it operates with are outstanding. Amazon relies more on holding the inventory and becoming a dominant seller itself. Its huge scale and efficiency make it very difficult to compete with.
Widespread fulfillment centers enable customers to experience best in practice delivery. The enormous buying power of the company gives the customer the cheapest prices. This becomes self-fulfilling as Amazon achieves much of its sales via the growing number of Prime membership users.
Prime members provide the company with sticky subscription revenues and in return, they receive a wide range of benefits. These include free shipping and a whole lot of other extra incentives like discounts and faster delivery times. Streaming media and other various digital content is another key feature. Amazon obtains valuable customer information via their personal data and spending preferences.
Market Leader In Cloud Services
Amazon Go is an innovative convenience store concept that enriches the customer’s more traditional shopping experience. Who doesn’t like the idea of skipping the line and the cash register on the way out? This is just one example of countless areas of Amazon innovation.
It is challenging to come up with a fair price for Amazon stock.
We need to look far into the future because maximizing earnings is still a distant goal for the company. In the shorter term, there is plenty of focus still on growing the customer base and enriching their experience. One area that has highlighted the earnings potential of the company is their web services. They are a market leader in cloud services, take a look at the revenue numbers below.
Businesses of all sizes are turning to them whether it be for running their websites or their entire technology infrastructure.
Amazon don’t just benefit from the products they sell. Their marketplace services allow third party sellers to use the Amazon infrastructure to sell their own inventory.
They can take advantage of the Amazon fulfillment services or choose to handle this themselves. It creates a powerful competitive landscape where shoppers are even more likely to gravitate to. New businesses worldwide are born out of this opportunity set.
Online Shopping Continue To Grow
Operating with such a moat in these areas of the economy experiencing huge tailwinds is the best of both worlds. Whilst there is plenty of publicity surrounding the growth in online shopping, the theme is still relatively immature.
Such outstanding fundamental themes, unfortunately, come with jaw-dropping high triple digit forward earnings multiples. I simply can’t get my head around the growth that Amazon needs to achieve to justify such multiples. I get that they are looking a long way out and focusing on customers over profits in the shorter term. However, I just wonder if in future the company is looked upon in a different light from its customers due to is dominance.
How will they view price rises when they hear of the huge growth in profits in the future?
I find it difficult to also find useful reference points in history. Which other companies of this scale have I seen go on to on to justify such rapid earnings growth expectations? There is so much certainty implied in the Amazon share price with long-term growth projections. I don’t share such certainty with my own predictive capabilities of these long-term trends.
Alibaba Group Holdings Limited (NYSE:BABA)
Like Amazon in the US, Alibaba continues to dominate the e-commerce market in China. Despite the similarities, Alibaba has been keen to point out how its vision differentiates it. Its focus is not to play the role of the retail seller and maintain massive distribution centers. It prefers to see itself as helping others connect to do e-commerce.
Therefore, keeping the prices of the goods in the e-commerce market competitive may be less of a concern. It can rely more on commissions and advertising revenue as buyers and sellers wish to be part of their ecosystem.
Alibaba also sees the huge value of further entrenching the moat characteristics of its business via customer loyalty. Alibaba have placed more emphasis on rewards for not only purchases, but also user engagement.
For example, social media sharing, contributing to community forums and writing product views can generate rewards and loyalty. This gives the added benefit to Alibaba from in-depth insights on shopper preferences and behavior.
Strong Forecast Sales Growth
Forecast sales growth for Alibaba demonstrates the huge potential and rivals the best of the US tech giants.
Having a stranglehold on the e-commerce market in China provides it with a few unique tailwinds. Internet penetration is much lower in China than the US to begin with, offering more room for growth. The Chinese retail market was more fragmented prior to the e-commerce market establishing itself as a major theme.
Consumers in China, therefore, can be more easily swayed to embrace e-commerce in the future. These factors are likely to contribute to China capturing a larger share of online sales over time.
The desire for the Chinese to embrace technology can be witnessed by their adoption of mobile payments. Foreigners traveling to China can be amazed how the Chinese will pay for everything via mobile. Cash can be considered strange! Alipay is the leader in the market, with it and Tencent’s WeChat controlling about 90% of this space.
The battle to win over other regions in the world may be pivotal. At this stage, Alibaba has only a very small percentage of revenue coming from outside China. Amazon has far more revenue coming from offshore having focused on developed markets such as Japan and the UK. It is early days speculating about who may be successful in capturing markets such as India & South East Asia. It is an area that prospective investors should keep a close eye on though.
Discussing Alibaba shares should not be without mentioning various accounting concerns that many investors have. That could be part of the risk you face to gravitating more towards Alibaba which trades on more realistic earnings multiples. The forward P/E for the next couple of years is more consistent with a PEG ratio of less than 1. Alibaba’s listing in the US uses a corporate structure known as a variable interest entity (VIE). A balanced article that explores this in more detail can be found here.
I am not entirely comfortable with the high P/E and the VIE structure to express confidence in Alibaba shares now. I would however prefer them over Amazon. The growth prospects, moat characteristics and sector tailwinds look at least as exciting but with a much cheaper valuation.
I concede some of this is warranted because of those citing accounting transparency concerns. Yet I consider these concerns well covered in the media. There is a possibility of them being brushed aside if no major issues come up. If so it wouldn’t surprise me to see some strong relative outperformance from Alibaba compared to Amazon.