Potential Upside For Alibaba Group Holding Limited (NYSE:BABA) Not Without Risk

With a median price-to-earnings (or "P/E") ratio of close to 18x in the United States, you could be forgiven for feeling indifferent about Alibaba Group Holding Limited's (NYSE:BABA) P/E ratio of 19.8x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

With earnings that are retreating more than the market's of late, Alibaba Group Holding has been very sluggish. It might be that many expect the dismal earnings performance to revert back to market averages soon, which has kept the P/E from falling. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders may be a little nervous about the viability of the share price.

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Does Growth Match The P/E?

In order to justify its P/E ratio, Alibaba Group Holding would need to produce growth that's similar to the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 13%. This means it has also seen a slide in earnings over the longer-term as EPS is down 45% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 28% per year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 10% each year growth forecast for the broader market.

With this information, we find it interesting that Alibaba Group Holding is trading at a fairly similar P/E to the market. It may be that most investors aren't convinced the company can achieve future growth expectations.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Alibaba Group Holding's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E as much as we would have predicted. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.

Having said that, be aware Alibaba Group Holding is showing 1 warning sign in our investment analysis, you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.