Is Alibaba Group Holding Limited’s (NYSE:BABA) PE Ratio A Signal To Sell For Investors?

Alibaba Group Holding Limited (NYSE:BABA) is trading with a trailing P/E of 41.7x, which is higher than the industry average of 26.7x. While BABA might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Alibaba Group Holding

Breaking down the Price-Earnings ratio

NYSE:BABA PE PEG Gauge Apr 12th 18

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P/E is a popular ratio used for relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.

P/E Calculation for BABA

Price-Earnings Ratio = Price per share ÷ Earnings per share

BABA Price-Earnings Ratio = CN¥1099.07 ÷ CN¥26.333 = 41.7x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to BABA, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since BABA’s P/E of 41.7x is higher than its industry peers (26.7x), it means that investors are paying more than they should for each dollar of BABA’s earnings. As such, our analysis shows that BABA represents an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your BABA shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to BABA, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with BABA, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing BABA to are fairly valued by the market. If this is violated, BABA’s P/E may be lower than its peers as they are actually overvalued by investors.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.