The potential return is largely beyond our control. But the risk that we take can be assessed and compared more or less objectively.
Amazon’s higher average return comes with relatively low risk.
Statistical assessment of the risk parameters speaks in favor of Amazon.
Hand holding chooses wooden block cubes with risk word. Risk management concept.
When it comes to investment, we very often focus on assessing the potential return, which is largely beyond our control. But the risk that we take can be assessed and compared more or less objectively. And it is in this context that I propose to compare Alibaba (BABA) and Amazon (AMZN).
In my calculation, I used the monthly total price return since October 2014 – the day BABA started trading.
Let’s start with basic parameters.
The first thing that catches your eye is that Amazon’s distribution of returns is close to the normal distribution. This attests to the stability and predictability of results:
As for Alibaba’s shares, the histogram of its returns is not so close to the normal distribution:
Further. Amazon’s arithmetic mean monthly return is almost double that of Alibaba. However, Amazon shows less risk: its value of standard deviation is lower:
mean standard deviation
AMZN 3.16% 8.23%
BABA 1.62% 9.72%
Amazon’s semi-deviation (a measure of the fluctuation in returns below the mean) is also lower. At that, the coefficient of variation of AMZN’s return is lower than that of BABA. This means that for each percent of Amazon’s average return, there is less risk than for that of Alibaba. In other words, Amazon’s higher average return comes with relatively low risk. The perfect combination!
semi-deviation coefficient of variation
AMZN 5.6% 2.6%
BABA 6.78% 5.98%
Let’s take a look at deeper parameters. Median and arithmetic mean of monthly returns of Amazon are very close to each other, which indicates the symmetry of the distribution of returns. In addition, Amazon’s distribution of returns demonstrates positive skewness and excess kurtosis equal to 4.04. This means that, firstly, Amazon’s returns tend to deviate toward the positive side relative to the average values and, secondly, in comparison with a normal distribution (excess kurtosis of the normal distribution equals 3), the actual distribution of AMZN’s returns is more concentrated around the average value.
If you are confused, these graphs allow you to clearly understand the essence of these parameters:
Now let’s take a look at Alibab
Here is a similar situation, but it loses to Amazon. Median and arithmetic mean are close to each other. The positive skewness also is present, and excess kurtosis is 3.37. But both are lower than those of Amazon.
Now let’s take a look at the history of companies’ annual total price returns. In Amazon’s case, we have a lower standard deviation limit above zero:
In the case of Alibaba, the situation is worse. Here, the lower standard deviation is negative:
As you can see, historically, investing in Amazon has provided higher return at lower risk.
Amazon and Alibaba have a lot in common. Both companies are far from their quantitative and qualitative growth limits. At the same time, both companies have their own risks. In the case of Alibaba, it’s a sovereign risk. In the case of Amazon, these are risks associated with its size and market share. And at the moment, these risks are difficult to compare.
I understand that the analysis performed is based on historical data. And the future won’t necessarily be the same. But at the same time, one cannot deny the presence of inertia both in physics and in the field of human psychology, which determines the behavior of financial markets. Therefore, it is highly probable that a similar analysis will show approximately the same results in a decade. Therefore, at the moment, I am of the opinion that investing in Amazon is less risky compared to Alibaba Group.