Why the Smart Money is Buying Alibaba Stock

So we've talked about the business. We've talked about the risks. Now I wanted to explore why our super investors are buying into Alibaba. So if you've been living under a rock, in Q1 Charlie Munger and Monish Pabrai were buying. Then in Q2, Monash Pabrai continued to buy. And also guys, Spear and Phil Town bought in as well. Now these guys are some of my favorite investors to follow, full stop, because of their rational, long-term value investing strategies.

So in this video, we're going to try and scrape through what they've said publicly to see what their thoughts are about the pros and the cons of Alibaba. Also, stick around at the end of the video, and we'll also talk valuation as well. So with that said, let's get started.

[Music]

This video is brought to you by Sharesight. Sick of tracking your performance manually? Track capital gains, dividends, and currency fluctuations easily. And when it comes to tax time, have everything you need ready to go with just a click of a button. Try Sharesight for free or use the referral link in the description to get four months free when you sign up to an annual plan.

So let's start by talking about China. Most of us see Alibaba and agree at a basic level that the share price seems pretty cheap for the underlying business. But the reason it is so cheap is because a lot of investors are getting nervous about China itself and whether Alibaba will continue to thrive in that system. So let's firstly hear from Monish Pabrai about his views on investing in China.

"Mr. Pabrai, are you not afraid of China?"

"Yeah, I mean, like, so China's a good example of what we just spoke about. Is that I think it would be too wide a brush to take a complex country like China and, you know, put it into three sentences, if you will. So, I mean, I think there are great businesses and great management teams all over the world, and there are many of them in China. I mean, given my circle of competence, I think most of China would be off-limits for me just because I probably couldn't understand it well enough. A small sliver of it, I think I can understand. And especially if you look at businesses like, let's say, if you look at a business like Tencent or if you look at a business like Alibaba, these two companies specifically, very early in their journey had Western investors or non-Chinese investors. And both these companies, right from the beginning, I think of them more as being happened to be based in China and because it's such a large market, happened to have most of their operations in China. But they're really, in many ways, multinational in their views and how they look at things. They've had a lot of, I would say, non-Chinese infusion into their DNA and thinking very early. And many of those elements are a big positive for them. So, yeah, I mean, I would think that China would be a difficult country for most investors because, you know, you need to understand the nuances a little bit of it. I think can be understood."

I like how Monish approaches this question. He admits that, you know, even for him, China is complex and that most of it would be off-limits for him. You know, but he's found a small sliver that he can understand and feels comfortable making decisions about. From the rest of the answer, you can tell that he means the big Chinese behemoths like Alibaba and Tencent. I found his anecdote there very interesting. You know, very early in the piece, they had quite a large portion of their business owned by big-name foreign investors. This is a point that's covered well in the book "Alibaba: The House That Jack Ma Built," which is written by Duncan Clark. This foreign investment has helped them grow a lot, but it's also helped keep them really accountable, and this is a risk that a lot of people are concerned about—trusting the numbers that Alibaba puts out.

So next, I wanted to chuck it over to Phil Town and to a clip he put out a little while back about investing in China. So take a listen.

"And the problem, you may not be aware of this, but the problem is that China does not allow United States auditors to come in and audit a Chinese national company. So you don't get to go see what's really going on at Alibaba or what's really going on at JD. You just got to take their word for it. Now those companies are pretty well-known to have not been cooking their books, but others are maybe not so well-known, not so well-regulated. Several public companies that were listed in the U.S. market have gone into bankruptcy after the CEO did some heinous stuff with the accounting."

Now this is interesting because Phil actually comes off sounding very bearish on the idea of investing in China, yet he added Alibaba to the Rule 1 fund in the previous quarter. So why does he sound so bearish on investing in China? Well, it's because he's talking about most Chinese companies in the clip.

And like Monish said, for most Chinese businesses, he wouldn't be comfortable investing in them. But as you can tell from that little anecdote he mentioned in the middle of the clip, Phil, like Monish, is very confident that the big Chinese companies like Alibaba or Tencent or JD.com are trustworthy. So I think the fact that Alibaba has had large foreign investment for basically its whole lifetime, as well as, you know, preparing all of its financial statements as per the generally accepted accounting principles and having been audited by PwC for over 20 years, I think this really helps the super investors trust Alibaba's accounting so much so that they've all bought into it.

Right? But that's not all that investors are concerned about. Right? With Alibaba, late last year, we saw Jack Ma speak out about the Chinese banking rules, and immediately China just blocked the IPO of Ant Financial. It sounds like for Alibaba, another big risk to their business is the Chinese government coming after them to make sure they know who's boss. So let's hear Charlie Munger's take on this situation.

"Mr. Munger is a champion of Chinese stocks. How concerned is he about Chinese government interference, as seen recently with Ant Financial, Alibaba, and Mr. Jack Ma?"

"What, for example, is to stop the Chinese government from simply deciding one day to nationalize BYD?"

"Well, I consider that very unlikely. And I think Jack Ma was very arrogant to be telling the Chinese government how dumb they were and how stupid their policies were and so forth, considering their system. That is not what he should have been doing. And I think the Chinese have behaved very, very shrewdly in managing their economy and they've gotten better results than we have in managing our economy, and I think that that will probably continue. And sure, we all love the kind of civilization we have. I'm not saying I want to live in China; I prefer the United States. But I do admire what the Chinese have done. How can you not do it? Nobody else has ever taken a big country out of poverty so fast."

There you go. You know, Charlie Munger is a huge fan of what China has achieved economically across the last few decades. But he acknowledges that it is not a system where free speech is generally encouraged. So if you're the figurehead of a big Chinese company, it's probably a dumb move to point the finger at the government. Now, Jack Ma isn't the CEO of Alibaba anymore, but he's still a big shareholder, and he is the founder. So in that position, it's probably best to either, you know, just shut up and work within the rules that you're given or try and be a dear friend to the government if you want to maybe suggest changes.

So Charlie Munger is definitely of the opinion that Jack Ma should just do investors a favor and just shut up. But clearly, he doesn't see the Chinese government as a threat to his investment in Alibaba, as you can tell. He sees the idea of China nationalizing their big companies as highly unlikely because of his comment there on BYD. But there is still a fairly strong opinion out there that China might very well still hurt Alibaba with its proposed big tech crackdown over the coming years.

So next up, let's hear Monish Pabrai's take on whether this is a big threat to Alibaba.

"Yeah, we'd love to talk about Baba because they're in the news all the time. And, you know, they're competing head-on with kind of U.S. big tech. They also have Chinese tech that they compete with, with Tencent. So what's your overall thesis with Baba?"

"Well, it's an incredible business. I mean, if you look at Baba and Tencent and gonna wear their ecosystem and the mode and what they control. And, you know, all of that. And you know, look at the tailwinds from China. I mean, there's a lot to me to like, even more than the large U.S. tech just because I think that the tailwinds are so much stronger. There's some serious barriers to entry, I think, here. There are obviously going to be much larger revenues and profits and such in the future with all the different things they have going on. But you're starting from a very large base, right? So 600 billion plus market cap, it's very cheap. I think Baba is one of the cheapest players out there."

"What do you think the Chinese regulatory issues? I mean, do they ever get past those, or do you think they’re just part of doing business?"

"I think 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. 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 who's in charge, and such. So I don't, I don't really expect much more than what we've seen already."

So this is a really interesting point of view to consider, and honestly, this is my opinion as well. You know, the Chinese government wants total control, right? And doesn't want anyone disputing that. No sir. So if someone or some entity does get on their nerves, they will definitely put them in their place.

But when you're talking about Alibaba or Tencent, you're talking about huge companies that actually influence how well the Chinese economy functions. For example, Alibaba is responsible for 1.2 trillion U.S. dollars of gross merchandise volume per year. They have over 891 million active annual customers on their various platforms in China. Alipay has more than 1.3 billion annual active users, processes more than 17 trillion dollars worth of transactions per year, and has more than 80 million merchants and 2,000 partner financial institutions. You know, particularly in the case of Alibaba, they still pay, you know, four and a half billion dollars of tax per year. And on top of that, every transaction made on their e-commerce platforms will have a tax component, as you know, merchants sell their wares, all of which will of course benefit the government.

So, you know, for China to step in and really destroy Alibaba, they kind of would be shooting themselves in the foot. You know, as Monish says, they would be killing the golden goose. You know, Alibaba, like Tencent, as he says, is a crown jewel of China. So you really do have to ask whether the government really wants to crack down and impair their business all that much, especially when you know it will have a big impact on Chinese citizens more broadly.

So they are some of the clips that I found from the super investors that have bought Alibaba. But I think ultimately the reason that these investors have bought in isn't because there is no risk; of course, there's always some risk. But in their opinion, the risk is low versus the potential reward. You know, one of Monish Pabrai's classic lines is you're trying to find investments where heads I win but tails I don't lose much.

So we have to remember at the end of the day, the main reason these value investors would have bought Alibaba is that, yes, they believe it's a great business and all that, but it's also available at a great price. So for the last part of the video, let's look at Alibaba's current valuation, and we start with finding their growth rate, of course. Now, Alibaba over the past 10 years has grown its revenue at a compound annual growth rate of 60, earnings per share 66, free cash flow 57. Now they are some amazing, amazing numbers, but you would be a fool to think a company with 1 billion active customers already and 450 billion dollar market cap will be able to grow at 60% annually for the next 10 years.

You know, as Monish has said, it's simply too big to keep powering ahead at this pace. But let's say Alibaba can still grow at, say, 10% annually, conservatively. 13% annually is maybe a middle value, and then we'll do 16% as an upper value. And by the way, I would really highly recommend you go and watch a video made by Investing with Tom titled "How Large Can Alibaba Grow." There's a really good breakdown of Alibaba's potential future growth from here. So I definitely, definitely recommend you check that out. Also, Tom has done really quite extensive coverage on Alibaba as well, so definitely worth checking out his channel if you want to learn more about Alibaba.

But, you know, back on valuation, if we assume only 10% annual growth in free cash flow and we want a 15% annual return, well, we hit an intrinsic value of $462.9 billion for the business. Now that's funny because it's actually exactly what the market cap is right now. The current market cap is 462.9 billion. So at 10% growth per year, the current price is in line with the intrinsic value but with no margin of safety.

Then at 13% annual growth, we have an intrinsic value of 571 billion. Again, this is us getting 15% returns per year, which overall gives us a 20% margin of safety. Then finally, at 16% annual growth, we get an intrinsic value of 707 billion, which would mean right now the shares trade at a 34% margin of safety.

So no doubt this is very interesting, but here's the thing: these numbers are just based off of e-commerce growth. The growth rate is based off of e-commerce, and right now we know Alibaba Cloud currently doesn't contribute to the cash flow pile as it still runs at a loss. And the results of Ant Financial don't hit Alibaba's numbers either because it's a separate company. It's just a separate company that Alibaba owns a one-third stake in.

So if you're bullish on Cloud into the future and you're also bullish on Alipay, then the deal actually gets a little bit sweeter than the DCF numbers we just looked at. And I think ultimately that explains why a lot of super investors want in. Yes, there are risks, but as Monish Pabrai says, we’re looking for those opportunities: heads I win, tails I don't lose much. And from just a basic discounted cash flow, it looks as though Alibaba fits that statement.

But of course, do not take this video as gospel. Definitely do your own research and come to your own conclusions on this one. You know, definitely acknowledge this video swayed a little bit more into reasons why the stock might be interesting because we've looked at investors that have bought into it. There's also plenty of viewpoints as to why some people would never touch the stock. So definitely remember to do your own research and draw your own conclusions, particularly on a stock like Alibaba, where there definitely are some risks out there.

But with that said, that will do us for this video, guys. I hope you enjoyed it looking at some of the super investors, what they have to say about Alibaba, looking at a couple of models for valuation, seeing maybe where the shares sit at the moment. So I hope you enjoyed it. Leave a like on the video if you enjoyed it or if you found it useful. Subscribe to the channel if you're new around here. Check out the clips channel link down in the description. Actually, the link should be coming up on the screen right now. Head on over to New Money Clips. We've got even more content about Alibaba over on the New Money Clips channel, so definitely subscribe. Trying to get that one launched up off the ground, up and running.

So if you wouldn't mind doing me a favor, please head over, give one of the videos some watch time, subscribe to the channel, and I would really appreciate it. But, guys, with that said, that'll do me today. Thanks very much for watching. I'll see you guys next time. Thanks again to Sharesight for sponsoring this video.

So recently, I finally decided to stop being lazy, and I imported all of my stock portfolios across into Sharesight. Finally, I should have done that a hell of a lot sooner. So with Sharesight, you sign up, you link your Sharesight account with your stock broker, or you just add your positions manually. And then from there, Sharesight tracks everything for you. It tracks your capital gains. It tracks your dividends. It'll track your dividend reinvestment plans. It'll track gains and losses from currency fluctuations. Seriously, this is by far the most thorough portfolio tracker I have ever seen.

And because they track and record everything so thoroughly, they can provide you with all of these reports—from literally simple performance reports to complex predicted future cash flow reports, if you're a dividend investor. But here's the really good thing. They also provide all of these detailed reports for tax time—so send these reports to your accountant, done. You know, plug these numbers into your tax return, done. Simple as that. It's a big, big help, and most of these features are available for free. But to be honest, you get the best experience. I would personally bite the bullet and upgrade to a paid plan. Honestly, this is one of the few stock market-related subscriptions that I would actually recommend. It's very, very helpful, particularly when it comes to tax time.

Anyway, if you did want to sign up, simply use the referral link in the description, or you can go to sharesight.com forward slash newmoney, and Sharesight will give you a special offer of four months free when you sign up to an annual plan. So at least sign up for the free plan; it will make your life easier. But, uh, that's it for today, guys. Thanks very much to Sharesight for sponsoring this content. And I'll see you guys next time.

[Music]

Uh

[Music]