If you had purchased $1,000 worth Alibaba (BABY -3.19%) stock at an all-time high of $317 at the end of 2020, you’d only be worth $230 today – a 77% decline. And while the company’s valuation now looks attractive compared to those of e-commerce rivals Amazon, investors should keep an eye on slowing revenue growth and an increasingly unpredictable regulatory environment in China. Let’s dig deeper.

What went wrong for Alibaba?

With a market share of 47%, Alibaba is the undisputed leader in Chinese e-commerce. And its influence extends across several industries, including brick-and-mortar retail, logistics, and cloud computing (where it controls 37% of that segment). Alibaba’s scale gives it an economic advantage through network effects. More customers attract more merchants, which increases competition and the quality of product listings. The e-commerce business creates a “captive” market for other services such as payment processing and other financial services.

Until recently, Alibaba’s many advantages have helped it maintain a healthy growth rate, with revenue rising 32% year over year to $28.6 billion in 2021. But now its future looks bleak due to a slowing top line, coupled with an environment unpredictable and harsh regulation. .

The problem with investment in China

Unlike financial metrics like revenue and earnings, political and regulatory risks are extremely difficult to quantify or predict — especially in less transparent jurisdictions like China.

According to Time magazine, Alibaba’s problems may have started after its founder Jack Ma called for reform of the country’s financial and regulatory system. Within weeks, the controversial billionaire was called in for questioning, and the planned spin-off of Alibaba’s $37 billion financial subsidiary, Ant Financial, was put on hold despite previously getting the green light.

This was the first of many adverse regulatory actions against Alibaba (usually related to alleged antitrust violations). And for investors, the episode highlights an alarming excess that could affect the company.

Flashing red stock charts sell

Image source: Getty Images.

Another red flag is the deteriorating relationship between the US and China. In October, the US commerce department announced landmark regulations designed to limit the sale of semiconductors and chip-making equipment to Chinese companies. For Alibaba, this is a major blow to its ambitions in technologies such as cloud computing, which rely on this advanced equipment. Alibaba’s cloud segment accounted for 9% of total revenue (17.7 billion RMB or $2.4 billion) in the second quarter.

The Revenue Commissioners are slowing down

Alibaba’s first quarter fiscal results show its weakening financial position. Revenue was flat year over year at $30.69 billion as a 1% decline in the China e-commerce segment was offset by a 10% increase in cloud computing. Adjusted earnings before interest, taxes and amortization (EBITA) fell 18% to $5.14 billion as the company struggled with challenges like China’s zero-covid-19 policy, which squeezed its margins.

While management has not provided guidance for the future, regulatory challenges such as China’s strict COVID-19 policy and the US chip export ban could turn the current slump into a long-term problem.

Alibaba stock is cheap for a reason

While Alibaba’s forward price-to-earnings multiple of just 9.3 is low compared to those of US rivals such as Amazon (which trades at 48 times projected earnings), the company’s political and regulatory headwinds represent a risk that is difficult to account for just by looking at its financial metrics. Investors should avoid Alibaba stock as these challenges don’t seem to be abating anytime soon.

John Mackey, CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fool’s board of directors. Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has jobs in Amazon and recommends. The Motley Fool has a disclosure policy.

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