Few market sectors offer the potential that China or e-commerce do. 

The Chinese economy has been a huge source of growth for companies around the world over the past several decades. China's gross domestic product has regularly grown by 7% or more during that time. As of early 2019, it was the world's No. 2 economy behind the U.S., and it's set to move into the top spot by 2030, according to a study by PricewaterhouseCoopers.  

The country's economic growth has decelerated in recent years. It clocked in at 6.6% in 2018, its slowest pace in 28 years, as trade tensions and a government crackdown on debt weighed on growth. But that growth rate is still much faster than that of any economy in the developed world. By volume, China still represents the world's biggest economic growth opportunity. 

Meanwhile, e-commerce -- defined as online retail or electronic commerce -- has also become one of the business world's biggest growth engines. In the U.S., e-commerce sales topped $500 billion last year, and the sector has consistently grown by about 15% annually since the 2008-2009 financial crisis, now making up nearly 10% of total retail sales. In China, e-commerce is growing even faster, with sales rising 25% to $1.05 trillion last year. The category now makes up 18% of total retail sales in the country, up from 11% in 2015. 

An Asian man delivering a package.

Image source: Getty Images.

An exploding middle class has created a new consumer culture in China in barely a generation. That, along with infrastructure investments that have made shipping easier, and the Chinese embrace of technology including smartphones, has led to the country's sudden growth of e-commerce.  

Risks in investing in Chinese e-commerce stocks

Now that we've highlighted some of the growth opportunities in China's e-commerce sector, we should also take a look at some of the risks. 

The foremost dangers appear to be China's slowing economic growth and its trade tensions with the U.S. Chinese stocks largely fell last year, and even entered a bear market, mainly because of those concerns; the Shanghai Composite fell 25% in 2018. Chinese retailers, both on- and offline, have reported that consumers are holding off on big-ticket purchases like electronics and appliances, and the broad Chinese economy has also been pressured by tariffs on exports to the U.S. There have been some indications that the two sides are moving closer to a compromise, as President Trump pushed back a March 1 deadline to raise tariffs on certain Chinese imports from 10% to 25%. But more recently, he's said that tariffs would be in place for "a substantial period of time" even if a deal is reached. 

A broader slowdown in the Chinese economy would put pressure on e-commerce stocks. China's own economic figures can be unreliable, and there are indicators beyond the headline numbers of a sharp slowdown. Car sales were falling by double digits at the end of 2018, and factory data and the key Purchasing Managers' Index, which measures the health of the manufacturing sector, have begun to show contraction in some months. Concerns have also returned about China's real estate bubble bursting. 

Because e-commerce stocks tend to be fueled by high growth and often have little or no profits, they are especially sensitive to macroeconomic factors. They also tend to trade at high valuations and would be vulnerable to slowing growth rates that would come from lagging economic growth. Given that, Chinese e-commerce stocks are best-suited to risk-tolerant growth investors, especially those with longer time horizons who can stomach near-term volatility from macro issues.

How should I analyze Chinese e-commerce stocks?

Chinese e-commerce stocks bear a number of similarities with their American counterparts, and investors will want to look for some of the same strengths and advantages that they look for in American e-commerce stocks. Among those, investors should pay attention to the following key metrics:

  • Revenue growth is a key indicator of strength in e-commerce, since direct selling often yields low profit margins. Many operators are also focused on growing their top line and gaining market share for now, and plan to use that scale later to drive profits. According to the Chinese National Bureau of Statistics, online retail sales of goods and services increased 23.9% in the country in 2018, and online sales of goods were up 25.4%. Those are attractive growth numbers, but investors will want to look for companies that are growing faster than the national average, which signals that they are gaining market share on competitors.
  • Gross merchandise volume, or GMV, is also important to keep an eye on. Revenue doesn't always capture the full picture of the business, especially for marketplaces like Alibaba, which rely on sales from third-party vendors to drive their businesses. GMV represents the total sales on a platform, as opposed to just direct revenue. Marketplace businesses generate revenue through sales commissions, as well as add-on services like payment processing, advertising, and shipping. For these companies, GMV and GMV growth often give a better estimate of the underlying strength of the business and the popularity of the platform than revenue, which can be manipulated more easily.
  • Profit margin is also worth focusing on. Investors will want to see evidence that e-commerce companies are taking steps toward profitability if they aren't profitable. Investors should keep in mind that marketplaces will generally have significantly higher profit margins than other types of e-commerce companies such as direct sellers, and judge each type of stock accordingly. The most important factor here is that the company can demonstrate a path to profitability.
  • Relationships with other companies are one key factor to watch in China. Chinese companies are often highly interconnected and have a number of partnerships or investments with giants like Alibaba or Tencent, and many also have close relationships with American multinational companies. Those investments show that these companies have high-powered backers, valuable relationships they can leverage, and funding sources they can tap if needed.

What are the best Chinese e-commerce stocks for 2019?

Applying some of the guidelines above -- strong revenue and GMV growth, a path to profitability, and partnerships with large American and Chinese companies that signal competitive advantages -- presents several appealing options. Based on those factors, below are five Chinese e-commerce stocks that look set to outperform this year and beyond:  

Company Ticker Description
Alibaba (NYSE:BABA) Owner of e-commerce marketplaces Tmall and Taobao, and related logistics and delivery services
JD.com (NASDAQ:JD) Operates primarily as a direct seller, but also runs a marketplace, and has its own delivery and logistics network
Baozun (NASDAQ:BZUN) E-commerce services provider for multinational companies in China
Uxin (NASDAQ:UXIN) Online marketplace for selling used cars
Pinduoduo (NASDAQ:PDD) "Social shopping" platform enabling consumers to get bargain prices by joining other shoppers

Data source: Company filings. 

Let's take a look at what each stock has to offer. 

Why you should invest in Alibaba

No Chinese e-commerce company is better known than Alibaba, which dominates the market in China with a 58% share of e-commerce sales. Like its tech-giant counterparts in the U.S., Alibaba's business extends into a number of related categories, including cloud computing, digital payments under AliPay, and even banking with Ant Financial. However, e-commerce remains its biggest business.

Its e-commerce platform is underpinned by two marketplaces, Taobao and Tmall. Taobao is similar to eBay in the U.S., hosting thousands of individual sellers, and it's China's largest mobile commerce destination. Tmall, on the other hand, is more of a curated site, hosting brands like Nike, H&MEstee Lauder, and Zara. It's China's largest third-party platform for brands and retailers. Those businesses generated 71% of Alibaba's $39.9 billion in revenue last year.

With those leading platforms, Alibaba enjoys significant competitive advantages, as retailers both foreign and domestic look to the company to reach China's online shoppers. Nike, for instance, launched on Tmall in 2012, and recently added a flagship Jordan brand store, saying at the time that it would deepen its relationship with Tmall. More recently, a Starbucks-Alibaba partnership let the coffee giant establish "Delivery Kitchens" in Alibaba-owned Hema supermarkets, leveraging Alibaba's on-demand platform for ordering and delivery. 

Alibaba's unique combination of assets, which include its e-commerce platforms, Ele.me food-delivery service (similar to Grubhub), Cainiao logistics service, Alibaba Cloud, and AliPay, among others, reinforce one another, building synergies, competitive advantages, and barriers to entry. 

That explains why Alibaba is growing quickly. Revenue rose 58% in 2018 with the help of some acquisitions, and the company posted a fat profit margin of 25.6% last year. Alibaba's GMV reached $769 billion last year, up 28% from the previous year. Given these promising figures, Alibaba looks like it should be able to move higher, especially considering the growth in the Chinese economy.

Why you should invest in JD.com

Alibaba's closest competitor, JD.com -- the No. 2 Chinese e-commerce company -- is actually bigger than Alibaba by revenue, because JD employs a direct-selling model in addition to operating a marketplace. It brought in $67.2 billion in revenue last year, up 27.5% from the year before. 

With a different model from Alibaba, JD enjoys some notable advantages. It owns more than 550 warehouses around China and operates its own delivery system, lowering costs and keeping hold of business that would normally go to another company. Amazon has gained a competitive advantage in the U.S. by leveraging logistics to provide fast delivery, and JD.com's warehouse network seems poised to do the same.

JD.com hit a couple of speed bumps last year, including the surprise arrest of Richard Liu, its CEO, on rape allegations, though the charges were eventually dismissed. The company also missed earnings estimates several times last year as it invested in infrastructure and dealt with slowing Chinese economic growth. However, there are already signs that the company is turning the corner, and not just because the stock is recovering.

Revenue from the higher-margin services segment, which includes its marketplace, advertising, and logistics, jumped 50.5% to $6.7 billion in 2018, and operating margin at JD Mall, its e-commerce business, improved from 1.4% to 1.6% last year. 

JD's technology and content expenses nearly doubled last year as the company has stepped up efforts in areas like automation and artificial intelligence, and it even opened a highly automated warehouse in Shanghai with just four employees. Those investments explain the disappointing profits last year, but they should eventually pay off, especially as the company counts on Tencent, a major investor, whose WeChat app is driving traffic to JD.com's website. By contrast, links to Alibaba properties are blocked on WeChat. JD has also forged partnerships with Walmart and Alphabet, both of which have taken stakes in the company.

The company has a different, but equally valuable, set of strengths from Alibaba. Its model may take longer to deliver results, but it's clear that JD is building a powerful set of competitive advantages. Recovering from the stock's recent losses alone would allow shares to nearly double, meaning there's plenty of upside potential this year and beyond for JD.com.  

Why you should invest in Baozun

Unlike Alibaba or JD.com, Baozun operates primarily as an e-commerce services provider for multinational companies doing business in China. The company describes itself as "the leading brand e-commerce solutions provider" in the country, providing services like IT solutions, marketing, customer service, warehousing, and fulfillment. It has also drawn comparisons to Shopify, though Baozun's services go beyond software.

Among Baozun's clients are Philips, Nike, and Microsoft as the company has become a popular partner for foreign companies looking to navigate China's complicated business environment. Baozun's market share has also risen from 22% in 2015 to 25% in 2017, showing the business is strengthening. 

Like its peers, Baozun is seeing strong top-line growth with revenue up 30% to $784.4 million last year. And its margins continue to expand as its services segment is outgrowing its direct-sales business. Services revenue was up 52.2% to $418.3 million last year as the company expands existing brand partnerships and adds new customers. Growth in the services segment helped drive operating margin from 6.2% to 6.6%, and adjusted net income increased 30% to $50.3 million. GMV, meanwhile, rose 54% to $4.7 billion in the year. 

As the leader in e-commerce services with more than triple the market share of its closest competitor, Baozun is an attractive proposition for potential partners, and the company also counts on backing from Alibaba, which owns about 16% of the stock and has two of its executives on Baozun's board. Softbank, the prolific Japanese investor, owns 12% of Baozun. Alibaba's partnership in particular should create synergies as the e-commerce giant can steer brands and retailers that sell on its platform to Baozun.

Accelerating revenue growth has been a bright spot for Baozun recently. It reached 40.7% in the fourth quarter, a key period that includes the popular Chinese shopping holiday Singles Day. Revenue is surging as the company has stepped up investments in sales and marketing and technology in order to capture more of the fast-growing e-commerce solutions market. Though those investments weighed on the bottom line, they appear to be paying off in top-line growth.  

With accelerating revenue growth, Baozun is showing it can perform even in a slowing economy, yet another reason to bet on the stock's comeback this year. Analysts see earnings per share nearly doubling to $1.48 this year. Based on that forecast, Baozun looks cheap with a P/E ratio near the market average.

Why you should invest in Uxin

Arguably the riskiest stock of the bunch, Uxin (pronounced yoo-shin) has already had a rocky time on the markets since it debuted last June. The online used-car marketplace operator offered its shares at $9 during a time when Chinese stocks were falling out of fashion, and it has since seen them fall to below $4.

Despite that inauspicious beginning, there are a number of reasons that the stock could recover this year. 

First, Uxin is the leader in an industry that has natural competitive advantages. Marketplaces are appealing business models for investors because they contain both network effects and switching costs, which have a way of locking customers and sellers in.

Customers are going to flock to the platform with the most sellers, and sellers, in turn, will be attracted to the marketplace with the most customers, creating a natural monopoly. Therefore, as the network gets bigger, its market-share gains are likely to accelerate as it blocks out competitors. Marketplaces like Uxin also benefit from switching costs as dealers who rely on the platform regularly will have to spend time and resources creating and managing accounts and adding and updating inventory, which is more costly to do on multiple platforms than just one.

At the time of its IPO, Uxin was China's leading online used-car platform, with 41% market share in its consumer-focused used-car segment and 42% market share in the dealer-focused auction business. Uxin's top-line growth shows the opportunity in the sector as revenue jumped 70% last year to $483.1 million. Furthermore, the company established a partnership with Alibaba's Taobao marketplace last December that should help drive continuing revenue growth. The partnership got off to a fast start: Uxin said it facilitated more than 2,000 transactions in the first 18 hours of Taobao's Double 12 shopping festival. 

Uxin has historically operated at a loss because of heavy spending on sales and marketing to pursue the huge opportunity in online used-car sales, and it reported a loss of $224.1 million last year. However, its marketing spending was flat in the fourth quarter, and the company said it turned profitable in December as revenue hit an annual run rate around $800 million with the help of its new store on Taobao. 

If the company can carry that momentum into 2019, the stock should bounce back from last year's sell-off.

Why you should invest in Pinduoduo

Almost no company in the world is growing as fast as Pinduoduo. The social shopping phenomenon saw revenue jump a whopping 652% last year to $1.91 billion as GMV soared 234% to $68.6 billion. 

Based on those numbers, Pinduoduo is still relatively small player in Chinese e-commerce, compared to Alibaba and JD.com, which control roughly 75% of the market, but the social shopping star is fast gaining on them. Pinduoduo operates through an innovative platform that encourages shoppers to form teams to score bigger discounts on items, making it a "social shopping" experience.

That design, which works through Chinese social networks such as Tencent's WeChat and QQ, has led to Pinduoduo's skyrocketing growth as team buying gives purchasers discounts of up to 90% on items like electronics. Over the last year, the number of active buyers on the platform jumped 71% to 418.5 million, and average monthly active users increased 93% to 272.6 million. Both figures show that Pinduoduo has captured a broad swath of Chinese consumers in just a short period of time; the company was only founded in 2015. 

Pinduoduo counts Tencent as a principal shareholder and a key collaborator as it relies on Tencent properties like WeChat and QQ to gather shoppers and direct them to Pinduoduo. 

Like other fast-growing young companies, Pinduoduo is not profitable. The company had an operating loss of $1.57 billion last year, but that owed largely to aggressive spending on sales and marketing, which totaled nearly $2 billion in expenses last year, slightly more than the $1.91 billion the company brought in in revenue. High-growth companies often spend aggressively on sales and marketing in order to drive growth and gain market share, and shift to focusing on profitability as they mature. Pinduoduo seems to be pursuing this strategy as the company could be profitable today if it scaled back on sales and marketing spending.

With its skyrocketing growth and steep losses, Pinduoduo is certainly a risky stock. It already carries a market cap near $30 billion, but it's hard to ignore a company growing its top line by triple digits and fast grabbing market share in a country the size of China. 

2019 and beyond

Much like last year, when Chinese stocks fell on macro concerns, broader issues in the Chinese economy and trade negotiations with the U.S. are likely to determine the trajectory of these stocks in the short term. If the Chinese economy continues to slow and tariffs remain or even increase, these stocks are likely to swoon again.

However, it's clear that China is still the fastest-growing large economy in the world, and e-commerce is quickly gaining share on the overall retail market, making it a top-notch opportunity for growth investors. E-commerce in China is growing faster than it is in the U.S. and makes up a larger percentage of retail sales in China than it does in the U.S. Both of those facts bode well for the sector's continuing growth.

Alibaba, JD.com, Baozun, Uxin, and Pinduoduo all demonstrate competitive advantages and are leaders in their respective sectors. Over the long term, there's a good chance that they will prosper and outperform the broader market.