Shares of JD.com (NASDAQ:JD), the second largest e-commerce player in China, are down about 5% this year. That's a disappointing return compared to market leader Alibaba (NYSE:BABA), which has rallied more than 10%.
JD's stock was weighed down by concerns about its rising expenses, competition from Alibaba's Tmall, and escalating trade tensions between the U.S. and China. However, that sell-off also has turned JD into an undervalued growth stock for four simple reasons.
1. It's still growing like a weed
JD's revenue surged 33% annually during the first quarter, its GMV (gross merchandise volume) jumped 30%, and its annual active customer count climbed 28%, to 301.8 million. Analysts expect its revenue to rise 31% for the year compared to 40% growth in 2017.
JD's rising operating expenses caused a double-digit drop in non-GAAP earnings last quarter, but Wall Street expects it to move past those costs and generate 30% earnings growth this year. That's because the temporary drop in JD's earnings was caused by higher investments in its logistics network, new warehouses, artificial-intelligence-driven ads and analytics, fresh e-commerce partnerships, and new brick-and-mortar stores -- which should all bolster its earnings over the long term.
2. Ridiculously low valuations
JD's stock is undervalued relative to its growth potential. At $39.50, it trades at just 0.8 times this year's revenue estimate and 0.6 times next year's estimate. Those ratios indicate that the market seemingly values JD as a brick-and-mortar retailer instead of an e-commerce giant. By comparison, Alibaba trades at eight times this year's sales.
JD trades at 73 times last year's non-GAAP earnings, but it only trades at 56 times this year's earnings and 32 times next year's earnings. Analysts also expect JD to follow up its 30% earnings growth this year with 76% growth next year. If JD meets those expectations, its forward multiples could drop as the market revalues the stock.
By comparison, Alibaba trades at 29 times this year's earnings and 22 times next year's earnings. Those price-to-earnings (P/E) ratios are lower than JD's, but analysts expect Alibaba to generate slower earnings growth of 26% this year and 34% growth next year.
The bears likely will point out that JD has much lower margins than Alibaba, but the two companies' margins aren't directly comparable. JD's margins are lower because it fulfills most of its orders via its own logistics network. Alibaba mostly relies on third-party logistics providers and doesn't actually take ownership of most of the products that are sold across its marketplaces.
3. Google's recent investment
Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google recently invested $550 million in cash in JD. Google received 27 million newly issued Class A shares in JD with an issue price of $20.29 per share. Each ADR represents two Class A shares, so Google's investment values each ADR at $40.58. Google wouldn't have made that investment if it thought JD was overvalued.
Google will let JD sell some of its marketplace products in the U.S. and Europe via its Google Shopping product search and price comparison platform. That deal could help JD counter Alibaba's AliExpress service for international shoppers and complement the expansion of JD Worldwide, which lets Chinese customers purchase overseas goods.
The partnership also could help JD expand across Southeast Asia, where Google is the dominant search engine, and possibly help it sidestep some of the trade tensions between the U.S. and China. Citi analyst Alicia Yap recently called the partnership "quite strategic and meaningful" for both companies.
4. A growing number of anti-Alibaba allies
Google's investment in JD also is aimed at countering Alibaba's growth in the cloud and e-commerce markets. Meanwhile, tech giant Tencent (NASDAQOTH:TCEHY) is currently JD's top investor, and the two companies already co-invested in retailers including Vipshop and Better Life. Both companies are also partnered with big brick-and-mortar retailers including Walmart.
Tencent owns WeChat, the top mobile messaging app in China with over 1 billion monthly active users. It integrates JD's marketplace into the app via ads and in-app "WeChat Stores," and pools its user data with JD's to analyze shopper behavior. Vipshop, Walmart, and other partners pool their resources with JD's in similar ways.
That's why JD's share of China's business-to-consumer market rose from 17.7% to 32.9% between 2014 and 2017, according to Analysys International Enfodesk. During that same period, Alibaba's Tmall's share slid from 54.6% to 51.3%. Therefore, it's doubtful that Alibaba will "kill" JD anytime soon.
The bottom line
JD's stock is currently weighed down by near-term headwinds, but it could generate big returns for investors who recognize its long-term potential. Undervalued growth stocks are rare in the Chinese tech market, and I think JD still has plenty of room to run.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of JD.com and Tencent Holdings. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), JD.com, and Tencent Holdings. The Motley Fool has a disclosure policy.