Alibaba: The Christmas Rout Brought A Risk/Reward Gift For Bold Investors

In our FY 2020 central scenario, we have dropped the revenue growth a bit, but we still expect the profit margins to hold. That being the case, we value the company at 30 times earnings (lower than the current 40x), which offers a 48% return on the current price. In the pessimistic scenario, we drop revenue growth significantly from the current levels. We’ve also lowered the profit margin and the valuation. Still, the result is a return of -25%. The optimistic scenario revolves around maintaining the revenue growth and slightly improving the profit margin. The valuation reflects that.

Given the current short-term macro scenario, we believe the price will fall somewhere between the pessimistic and normal scenarios. Bear in mind that positive developments around the trade negotiations will likely push the valuation towards the normal scenario. On the other hand, negative developments will depress the valuation, and therefore, converging with our negative scenario.

The current bear market in this stock has made the potential returns seem asymmetric, clearly favoring the upside (between the pessimistic and normal scenarios) by a significant margin. The optimistic scenario is a wild card on the upside, and at the current price, one can argue that investors are getting paid to have it.

For the long-term, Alibaba seems both a good macro and stock picking call. In the short term, the current macro uncertainty isn’t good for most stocks. However, the prevailing market depression is equally punishing many different stocks, and in my opinion, it is the cause of a very interesting risk/reward relationship in this company.

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