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Is Alibaba Group Holding Ltd (NYSE:BABA) the Best Undervalued AI Stock?

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5 months ago

June 21, 2024

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Is Alibaba Group Holding Ltd (NYSE:BABA) the Best Undervalued AI Stock?

We recently published a list titled 10 Best AI Stocks With More Upside on $1.2 Trillion AI “Value Creation Opportunity”. Since Alibaba Group Holding Ltd (NYSE:BABA) ranks 8th in the list, it deserves a deeper look.

UBS Global Wealth Management’s (GWM) recently published a detailed report discussing different layers of the AI “value chain,” estimating the combined market value opportunity from the layers at $1.2 trillion by 2027.

UBS segments the AI market into three layers – Enabling Layer, Intelligence Layer and Application Layer. The enabling layer is what actually powers the AI ecosystem — infrastructure, GPUs, data centers, Cloud, servers. UBS further divided this layer into two segments, Infrastructure and Cloud. The firm expects a combined $516 billion revenue opportunity from the enabling layer by 2027.

Next up is the intelligence layer, which acts as the brain of the entire AI ecosystem. Large language models and backed software systems sit at this layer. UBS estimates that this layer presents a $225 billion opportunity by 2027.

The third layer in the AI market highlighted by UBS is the application layer. This is where the end user comes in. Cloud, data centers, GPUs, LLMs and algorithms amount to nothing if the end user cannot benefit from their huge processing power. UBS said estimating monetization opportunity of this layer was the hardest since it’s still in its very early stage. The application layer addresses actual AI software used by customers — think AI assistants, GitHub CoPilot, marketing, customer service software, etc. UBS expects a whopping $395 billion in revenue opportunities for the application layer by 2027.

Key AI Predictions

The UBS report also made key “predictions” about the AI landscape. The firm’s analysts believe the race to achieve artificial general intelligence (AGI) could give rise to a “capex cycle” that could “inflate” the AI investment bubble. UBS sees the dominance of a few companies in the AI industry will continue to be a reality moving forward, as it expects “monolithic players” and “AI foundries” prevailing in the near future.

Based on this report, let’s take a look at the top companies that will directly benefit from this $1.16 trillion opportunity by 2027. For this article we analyzed UBS analysis and picked 10 stocks that are directly exposed to the three layers in the AI ecosystem highlighted by UBS in its latest report. These companies are positioned extremely well to benefit from the monetization opportunities in the enabling, intelligence and application layers of the AI market. With each stock we have mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).

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Alibaba Group Holding Ltd (NYSE:BABA)

Number of Hedge Fund Investors: 103

UBS is bullish on Alibaba Group Holding Ltd’s (NYSE:BABA) exposure to AI because of Alibaba Cloud, or Alibaba Cloud, which makes the Chinese company a formidable player in the AI enabling layer. In the intelligence layer, UBS highlighted Alibaba Group Holding Ltd’s (NYSE:BABA) Qwen large language model, while the Qwen agent makes the company’s presence notable in the application layer.

However, uncertainties in China and Alibaba Group Holding Ltd’s (NYSE:BABA) lackluster performance have damaged the sentiment around the stock. While Alibaba Cloud is a significant player in the market, analysts believe enormous growth and advancements of Alphabet, Amazon and Microsoft in the public Cloud markets have left Alibaba Group Holding Ltd (NYSE:BABA) behind. Wall Street analysts expect Alibaba earnings to grow at a CAGR of just 1.7% only over the next five years. Alibaba Group Holding Ltd’s (NYSE:BABA) forward PEG ratio is 3.29, which is high when we incorporate the unimpressive earnings growth expectations.

Alibaba Group Holding Ltd’s (NYSE:BABA) ecommerce business is also struggling as buyers in China become price-conscious amid a broader slowdown. However, Alibaba Group Holding Ltd (NYSE:BABA) bulls believe the stock could rebound if the situation improves in the country, given the company’s massive cash flow position. Alibaba Group Holding Ltd (NYSE:BABA) finished fiscal 2024 with a whopping $34.37 billion in cash on hand, with another $36.42 billion in short-term investments.

In May, Baidu analyst Colin Sebastian said in a note after Alibaba Group Holding Ltd’s (NYSE:BABA) quarterly results that the company was gaining “early momentum” as it changes its priorities.

“Alibaba is focused on recapturing e-commerce market share in China, and capitalizing on momentum in international commerce and cloud computing building on strong growth in cross-border volumes, and accelerating revenues in public cloud,” the analyst said.

Sebastian has an Outperform rating on the stock and an $85 price target.

Artisan Select Equity Fund stated the following regarding Alibaba Group Holding Limited (NYSE:BABA) in its fourth quarter 2023 investor letter:

“Pretty much all of our holdings rose during the quarter. Only one stock declined by more than a couple of percent—Alibaba Group Holding Limited (NYSE:BABA), which was down 9% for the quarter and 12% for the year. This investment continues to be a disappointment. We estimate the shares are trading at around 5X EBITA—a valuation normally reserved for a company with evaporating profits. While it’s true Alibaba is underperforming its peers in the market, the fact is it remains the market leader in its core businesses, and the business is still growing. In the most recent quarter, revenues grew 9% and profits grew 26%.It’s not evaporating.

The management seems to be making meaningful changes designed to enhance shareholder value, including structural changes to improve profitability and restore its competitive position. It is monetizing non-core assets and making improvements in capital allocation. A lot of good things are happening that are not yet recognized in the share price. There are reasons—primarily geopolitical—for this, but at the current valuation, we could easily see the shares double and they would still be cheap.”

Overall, Alibaba Group Holding Ltd (NYSE:BABA) ranks 8th on Insider Monkey’s list titled 10 Best AI Stocks With More Upside on $1.2 Trillion AI “Value Creation Opportunity”. While we acknowledge the potential of Alibaba Group Holding Ltd (NYSE:BABA), our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than Alibaba Group Holding Ltd (NYSE:BABA) but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

Disclosure: None. This article is originally published at Insider Monkey.