Why Charlie Munger Continues to Buy Alibaba Stock

The Daily Journal recently bought a large position in Alibaba after founder Jack Ma had been reprimanded by the Chinese Communist Party, and Ma's other company, Ant, was not allowed to proceed with its IPO. What are your current thoughts on China and whether the communist leaders will allow businesses with strong leadership to flourish in decades to come?

The Chinese government will allow businesses to flourish. It was one of the most remarkable things that ever happened in the history of the world when a bunch of committed communists just looked at the prosperity of places like Singapore and said, "The hell with this. We're not going to stay here in poverty. We're going to copy what works." They changed communism; they just accepted Adam Smith and added it to their communism. And that, now, we have communism with Chinese characteristics, which is China with a free market, with a bunch of billionaires, and so forth.

They made that shift; they deserve a lot of credit. Warren and I are not quite as good at that as changing our minds in many cases, and that was a remarkable change coming from such a place. And of course, it's worked like gangbusters. It had this enormous growth in the average income of the average Chinese; they've lifted 800 million people out of poverty fast, and there's never been anything like it in the history of the world. So my hat is off to the Chinese, and I think they will continue to allow people to make money. They've learned it works. The Chinese— I love what the guy said in the first place: "I don't care whether the cat is black or white as long as it catches mice." That's my kind of talk.

One of Warren Buffett's favorite quotes is, "Be greedy when others are fearful." Buffett's business partner, Charlie Munger, showcased that approach last quarter by doubling down on Alibaba stock while other shareholders rushed for the exit. Munger is best known as Buffett's right-hand man and Berkshire Hathaway's vice chairman. However, the 97-year-old has also been the Daily Journal's chairman since 1977 and manages the newspaper publisher and legal software provider's investment portfolio. Munger nearly doubled the shares that the portfolio owns this past quarter; Daily Journal boosted its Alibaba stake by 83% to more than 300,000 shares. It first started buying shares in the Chinese e-commerce group in the first quarter of this year. This has made such big news because this is the first new stock to be added to the investment portfolio since 2013.

In this video, we are going to explain Munger's rationale for buying the stock and why the stock price continues to decline. Charlie Munger is the ultimate long-term focused investor. One thing that he is confident in for the long term is that China's economy will continue to grow. Over the course of Charlie's nearly 100-year lifetime, he has seen China grow from an extremely poor country into a country that is on its way to becoming the world's largest economy. Alibaba's massive success over the past 20 years wouldn't exist without the explosive growth of the Chinese economy. As the second largest economy in the world, China has seen an average growth rate of 9.52% between 1989 and 2019, by far the largest growth rate of any large country.

China is the second largest economy at 14.14 trillion dollars, while the United States remains the largest economy at 24 trillion dollars. The reason some people are so optimistic about the future of China's economy is explained in one simple statistic: the GDP per capita. This is calculated by taking the size of a country's economy and dividing it by the number of people within the economy. In the case of the United States, that figure is 66,678 dollars per person; for Germany, it is 49,548 dollars; and for Japan, it is 43,597 dollars. For China, it is 10,710 dollars per person, less than one-sixth that of the United States, at a population of nearly 1.5 billion people compared to the United States' 330 million.

The potential of the Chinese economy is huge simply because the population is so large. If China is able to boost that per person GDP figure closer to that of more developed economies, its massive population would quickly lead to a huge economy. While China is still technically communist, China's economic reform program of 1978 was a large success in terms of economic growth and resulted in the rise in average economic growth from six percent to over nine percent. The reform program emphasized the creation of private and rural businesses, erased the state regulations on prices, and invested in workforce education and industrial output.

You don't have to be one of the all-time greatest investors to understand why Charlie Munger would want to invest in Alibaba. Here are three reasons why:

Number one: high growth. Alibaba has grown revenue at 60% per year on average over the past 10 years. The company grew free cash flow by 57% over the same time period, and arguably, the most impressive number is that Alibaba was able to grow earnings per share by 66% on average over the past 10 years. Just to put that number in perspective, I would consider a 10% earnings per share growth rate a very healthy earnings growth rate for a large company. Alibaba's earnings per share growth rate has been nearly seven times that on average for the last decade. Despite all of the negative news around the company, it has still been growing substantially this past year.

Take a look at these numbers from its most recent earnings release: Alibaba grew its e-commerce segment an impressive 35% year-over-year and its very important cloud computing segment 29% year-over-year. Total revenue for the company grew 34%. Very impressive for a company of Alibaba's size. To put this in perspective, Walmart, the world's largest retailer, grew revenue by 2.4% over the same period. Alibaba is obviously growing and it is growing quickly, and arguably most important is that the company is able to achieve this growth all while being profitable. Most companies that grow this fast, especially e-commerce companies, aren't profitable because of all the expenses associated with rapidly growing a business, such as hiring new people, advertising, investing in distribution centers, and warehouses. So the fact that Alibaba remains profitable during this growth is extremely impressive.

Number two: moats. The next reason why Alibaba is attractive is because the company has strong competitive advantages or what Charlie Munger and Warren Buffett would refer to as a moat. A moat is simply what helps the company maintain its current position in the market and fight off competitors who want to take the company's customers. Alibaba's founder, Jack Ma, describes Alibaba's moat as something called the iron triangle. Alibaba's iron triangle is a combination of e-commerce, logistics, and finance. This triangle consists of Alipay for payment, sign out for logistics, and this combination of payments and logistics creates a network effect for Taobao and Tmall. This concept is from the book "Alibaba: The House That Jack Ma Built."

Alibaba's e-commerce sites offer an unparalleled variety of goods to customers. Its logistics offering ensures these goods are delivered quickly and reliably. Alipay ensures that Alibaba can get paid via a process that is easy and worry-free. The other big moat is the fact that, let's just say, China isn't the most friendly country to non-Chinese companies entering their market. This creates what is referred to as investing as a barrier to entry. Put simply, a barrier to entry is something that prevents or makes it difficult for newcomers to enter an industry and, as a result, limits competition. It is very difficult for international companies to enter the Chinese market and try to compete against Alibaba.

For example, if I wanted to start an e-commerce company to compete against Amazon here in the United States, I could definitely give it a try. I likely would be very unsuccessful in this endeavor, given the huge size and dominant position Amazon has, but nevertheless, I could at least try. However, I wouldn't be able to do that in China today as an American without the Chinese government's approval.

The third point is that many people consider Alibaba to be undervalued. The stock is down more than 50% from its all-time highs in October 2020. Alibaba's current P/E ratio is 19. To compare that to other high-growth big tech companies, Amazon's P/E ratio is 57, Apple's is 28, Facebook's is 24, Alphabet's is 30, and Netflix's is 65.6. But despite all of these seemingly great reasons to invest in Alibaba stock, there is a reason why the stock's value has gotten cut in half from its all-time highs. That reason is the Chinese government and its policy known as common prosperity.

The hope is that the mix of policy moves, market forces, and philanthropy will address the country's wide and persistent wealth gap, which could become a political threat to the ruling communist party if left unchecked. And let's just say the Chinese government has done some things that aren't the most friendly towards investors in order to try to accomplish its goal of common prosperity. For example, the government of China essentially banned online tutoring companies from making any profits, effectively turning what was once considered by investors to be one of the faster growing areas of the Chinese economy into non-profits overnight.

Take a look at this chart: The new government policy caused the stock price of companies that operate in this industry to fall 70%, literally overnight. These actions have investors worried that further government actions from the Chinese government will hurt Alibaba's long-term profitability, and Alibaba has not been immune to this government crackdown. In fact, they are a main target of government policy. Late last year, Ant Group, which Alibaba owns 33% of, was gearing up to go public. Ant Group is a financial technology company and owns China's largest digital payment platform, Alipay. Ant Group had already met with investors, and everything looked to be going smoothly. The firm was expected to raise 37 billion dollars, and its valuation was reportedly nearing more than 300 billion dollars, making it one of the most anticipated initial public offerings of all time, as well as more valuable than Bank of America and JPMorgan Chase at the time.

However, right before the company was set to go public, Chinese regulators pulled the plug on the IPO. At the time, changes in the financial technology regulatory environment were blamed for the suspension of the listing. These actions over the past year definitely have investors worried, and at first glance, these worries seem entirely justified. So why are some of the biggest name investors piling into the stock despite these worries?

Let's listen to the legendary Monish Pabrai, a recent purchaser of Alibaba stock, explain why he is a buyer. "Alibaba is a crown jewel for China, just like Tencent is a crown jewel for them. So, I don't think they will want to do things. You know, these are the plays that can have the possibility of global footprints that they can get there. So, I don't think the government is going to take an approach which is going to, you know, kill the golden goose, if you will. My take is they've extracted their pound of flesh, and they've sent a pretty clear message about who's in charge, and such. So, I don't really expect much more than what we've seen already. Also, the other thing with Alibaba is that in the long term, I think a lot of the value creation for them is cloud, which is non-existent from an earnings perspective today. You know, they have some scale, but it’s, I mean, they’re the number one player. But I think that when you look at Amazon's numbers, and Amazon's numbers with cloud are somewhat misleading because they dumped their internal cloud expense in there. So actually, you know, 50 million, 50 billion revenue and 15 million, 15 billion net income is actually understated. So I think they're making more than 15 on that month because they're growing as well. You know, they're investing in all the future growth. So, the cloud margins are incredible, and the issue with the cloud is that very few people can play. I mean, in the U.S., the game is for the most part over. You know, you've got the players, and it will be hard to even see them changing the position they're in."

So there we have it. If you enjoyed this video, make sure to like the video and subscribe to the Investor Center because my goal is to make you a better investor. Talk to you soon.