Wednesday, January 25, 2017

Why I am bullish on Alibaba

Calculating Intrinsic Value of Alibaba using EPS discount model

This is my first attempt in trying to value a company in a blogpost. So here goes. Why Alibaba. As a frequent user of taobao, I find the coverage of US analyst with my view differs aplenty. Probably due to language barrier on using the platforms available in China. With their recent acquisition on Lazada, BABA has been able to in-coprate the company into their ecosystem quite well. I see Alibaba as a company more than an e-commerce platform. They used to be only that but the have evolved. They now provide media with the likes of Tudou and youku, they are also the leaders in cloud computing, Alipay which is their payment arm, Cainiao, their logistic arm. They have really a lot of business and I consider them a big data company. 

I believe in the future they will be bigger than even google or apple as USA has only 500mil people but China. China alone will have 500mil middle class in years to come. Talk about economics of scale. India is another counter but i do not understand Tamil nor is their market that accessible to trade. 

Alibaba itself has grow so big that I find it too big to fail. It has such a big economic moat in the form of their system itself. Imagine a day where Alibaba stop its business for just a day. The entire china economy ecosystem will crash. That's how critical they are now in China's ecosystem.

Well enough of my bullshit here goes with my calculation:

Calculating Intrinsic Value of Alibaba using EPS discount model

Reason for using EPS growth model. Alibaba is a company that is going to grow for the foreseeable future as the world is moving towards ecommerce. Alibaba and are the current market leaders in the e commerce space in china. The market penetration of e commerce in China currently stands at 20% of retail sales. This number is definately going to grow along the years.

Alibaba is set to join in this growth in years to come. Since the company is going to grow in its profit, the EPS will likely follow suit.

EPS Growth Capitalization Method

Step 1: Determine Future Stock Price

To determine the future stock price I will need to have 2 values
  • Future EPS
  • Future PE

Future EPS

The formula to compute Future EPS is as follows:

F = EPS ( 1+R)^N

  • F= Future EPS
  • EPS = Current EPS
  • R = Compound growth rate
  • N = number of years in the future

The first step is to determine the intrinsic value of BABA is to find out what the stock price of BABA will be in the future. EPS and PE will be required to calculate the future stock price.
Taking a 5 year horizon, we will need to find out the EPS of BABA in 5 years time. To get F, we will need EPS, R and N.

EPS - The current EPS of baba is 4.6237. This is the EPS for BABA Full year 2016

R - The compounded growth rate can be obtained by getting the CAGR of the company EPS

EPS went from 0.27271 to 4.6237 over 4 periods.

Due to CAGR being highly unsustainable at 102.92%, i will be using a 70% discount to the current growth rate.

Ignoring the CAGR being company specific, I will use a growth rate of 20% as global e-commerce market is expected to grow at around 20% per year. Until I can get a more realistic value in future, I shall use 20% for the current valuation

N - I will be projecting the price in 5 year times

All 3 variables are in place now. By putting the values into the equation:

F = 4.6237(1+0.2)^5
  = 11.505

The EPS in 5 years time Year 2021 is projected to be 11.5

Future PE

I will now need to find the future PE of BABA.

I will be using BABA historical data to try and find a suitable PE for this calculation.

The PE of BABA is extremely erratic
2012 - 329
2013 - 160
2014 - 57.94
2015 - 56.02
2016 - 19.43

The current PE of BAB stands at 47.88. Stripping away 2012 and 2013, I will take the average from 2014 to 2016. The calculation gives me 44.75

With these 2 data values, I will attempt to calculate the Future Price of BABA

  • FP = Future price
  • EPS = Future EPS
  • FPE = Future PE

This result in an estimate of $514.6 in five years time. This is of course in 5 years time the PE stays at 44 range. A lower PE will result in a lower valuation

Step2: Calculate Today’s Intrinsic Value

We will now need to work towards calculating the current value of BABA in today’s price. 514.6 will not be 514.6 today as we have to take into account inflation and internal rate of return.

The reason why we need to convert this to present day is because we need a number that we can compare to the price that the stock is currently trading. We cannot compare today’s punggol nasi lemak price to kovan nasi lemak price in 2020. It’s not going to be the same. 514.6 is not useful to us right now as there has been a lot of growth in that value. We will need to work backwards to remove that growth from the future stock price to see what its equivalent value is today

We will now need to determine the discount rate. The discount rate is the minimum growth rate we are willing to accept. So we will be able to get the price of the stock in today’s value and still be able to achieve that minimum growth rate. Assuming i want to make a 15% return on BABA per year for 5 years. I will then need to discount it be 15% annually to get today’s stock value.

The intrinsic present value calculation is as follow:

P = FP/(1+R)^N

  • P= present value of future price
  • FP = Future stock price
  • R= minimum acceptable rate of return
  • Number of years

With the following values we have computed, the intrinsic value makes out to be 222. The current price is in the 90’s range. Which is more than 50% discount to my calculated value.

Step 3: Apply Margin of Safety

If we draw a bell curve, my confidence level on the data i have input is at 50% hence I will take a 50% margin of safety on my final value. This throws out 111. At current price BABA is undervalued. I will seek to accumulate until the price goes above this number.

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