Shares of Baozun (NASDAQ:BZUN) tumbled 6% on Aug. 14 after the Chinese e-commerce services provider reported its second quarter earnings. Yet the decline, which extended Baozun's more than 20% drop over the past month, seemed unjustified since the company's numbers crushed expectations.

Baozun's revenue rose 31% annually to 1.16 billion RMB ($175.2 million), topping expectations by about $19 million and representing an acceleration from its 15% growth in the first quarter. Its non-GAAP net income grew 34% to 57.5 million RMB ($8.7 million), or 0.96 RMB ($0.15) per ADS.

A shopping cart icon on a smartphone app.

Image source: Getty Images.

So why did Baozun's stock tumble after those solid results? Let's take a closer look at its business, its second quarter growth, and its valuation to find out.

Understanding Baozun's business

Baozun is a "one-stop shop" for digitizing a business, serving China's growing e-commerce market. It offers companies digital storefronts, marketing solutions, customer relationship management services, IT services, and fulfilment services.

Baozun generates revenue from product sales and services. Its product revenue rose 14% annually to 577 million RMB ($87.2 million) during the quarter, while its services revenue rose 52% to 582 million RMB ($88 million).

The bears once believed that Alibaba and JD.com would render Baozun's services obsolete by putting up similar offerings for their online marketplaces. Yet Alibaba and JD integrated Baozun's services into their platforms instead, which made it easier for companies to set up online stores.

Understanding Baozun's strategy

Baozun's strategy, like Shopify's, lets it piggyback on the growth of the Chinese e-commerce market without operating a massive marketplace like Tmall or JD. Demand for Baozun's services has been rising -- that's why its total number of brand partners rose 16% annually to 162 last quarter.

Over the past few quarters, Baozun pivoted from a distribution-based model, in which it took ownership of the goods that passed through its platform, to a non-distribution model, in which its vendors sell goods directly to customers. This strategy helps Baozun keep its operating expenses under control.

A businessman holds a tablet displaying e-commerce icons.

Image source: Getty Images.

Baozun's total GMV (gross merchandise volume), or the value of all goods sold across its platform, surged 69% annually to 6.08 billion RMB ($880 million) last quarter. Within that total, distribution-based GMV rose 14% to 666 million RMB, while its non-distribution GMV surged 80% to 5.42 billion RMB.

But operating expenses are still rising

Baozun's shift from a distribution model to a non-distribution model keeps its fulfillment costs under control, but its operating expenses continue to rise across the board.

Operating expenses:

RMB (millions)

YOY increase

Cost of products

464.4 ($70.2 million)

5.4%

Fulfillment

277.7 ($42.0 million)

60.6%

Sales and marketing

273.1 ($41.3 million)

49.0%

Technology and content

65.2 ($9.9 million)

107.5%

General and administrative

38.7 ($5.8 million)

23.1%

Source: Baozun Q2 earnings report.

Baozun attributed the jump in fulfillment expenses to higher distribution GMV and warehouse rental expenses compared to the prior year quarter. It attributed its higher marketing expenses to a larger headcount for its online store promotional staff and elevated promotional expenses, and noted that higher investments in "innovation" and a higher tech-oriented headcount boosted its tech and content expenses.

As a result, Baozun's total operating expenses rose 29% annually. However, its operating income still rose 55% to 58.3 million RMB ($8.8 million), and its operating margin expanded from 4.2% to 5%. 

So why aren't investors biting?

Despite all those solid developments, investors are avoiding Baozun for two main reasons. First, Baozun expects its sales to rise 22% to 26% annually in RMB terms. That matches analyst estimates but represents a deceleration from the second quarter. If Baozun's operating expenses start rising at a faster rate than its revenues, its profit growth could grind to a halt.

Second, Baozun trades at over 40x this year's earnings. That multiple is arguably justified by analysts' projections for 26% sales growth and 68% earnings growth this year, but investors aren't eager to pay a premium for a Chinese tech stock amid escalating trade tensions between China and the U.S.

It's still a solid long-term play

Despite those headwinds, Baozun is still a solid long-term bet on China's e-commerce market. The company spends lots of money, but it remains well-insulated from any major price or ecosystem wars between Alibaba, JD, and other smaller marketplaces. It simply needs to keep bringing businesses online to keep growing.

Leo Sun owns shares of JD.com. The Motley Fool owns shares of and recommends Baozun, JD.com, and Shopify. The Motley Fool has a disclosure policy.