Pinduoduo's (NASDAQ:PDD) stock recently surged to an all-time high after the company posted its first-quarter earnings. The Chinese e-commerce company's revenue rose 44% annually to 6.54 billion yuan ($924 million), beating estimates by $189 million but marking its slowest growth rate since its IPO.

Its net loss widened from 1.88 billion yuan to 4.12 billion yuan ($582 million). On a non-GAAP basis, its net loss also widened from 1.38 billion yuan to 3.17 billion yuan ($448 million), or $0.39 per ADS -- which missed consensus estimates by $0.11.

Pinduoduo's post-earnings pop suggests the bulls weren't too concerned about its widening losses and were more dazzled by its robust growth in revenue and users. But did this e-commerce underdog really prove the bears wrong?

Two young women check a smartphone app while shopping.

Image source: Getty Images.

How fast is Pinduoduo growing?

Pinduoduo raked in 7% of China's e-commerce sales last year, according to eMarketer, putting it in third place behind Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD). Its group purchase platform, which encourages shoppers to team up for bulk discounts, gained momentum in lower-tier cities and carved out a defensible niche in China's crowded e-commerce market.

Pinduoduo's monthly active users (MAUs) rose 68% annually to 487.4 million, while its annual active buyers grew 42% to 628.1 million -- its strongest growth rate in four quarters. Its annual spending per active buyer rose 47% to 1,842.40 yuan ($260.20). These numbers all suggest Pinduoduo still has plenty of room to grow:

Growth (YOY)

Q1 2019

Q2 2019

Q3 2019

Q4 2019

Q1 2020

MAUs

74%

88%

85%

77%

68%

Active Buyers

50%

41%

39%

40%

42%

Annual Spending per Active Buyer

87%

92%

75%

53%

47%

Revenue

228%

169%

123%

91%

44%

YOY = Year-over-year. Source: Pinduoduo quarterly earnings.

But Pinduoduo is burning cash to subsidize that growth

However, Alibaba and JD are now challenging Pinduoduo with their own discount marketplaces in lower-tier cities. Pinduoduo retaliated by entering its rivals' top-tier markets and expanded beyond cheaper generic products with brand-name goods.

Three tiny parcels on a laptop keyboard.

Image source: Getty Images.

Pinduoduo persuaded merchants to sell their brand-name products on its platform, often at lower prices than Alibaba and JD, with aggressive subsidies. Pinduoduo subsidizes the difference between a merchant's listed price and its actual retail price, which allows it to sacrifice its margins to undercut its larger competitors.

This strategy is dangerous, since waging a subsidized war against Alibaba and JD -- which are both firmly profitable -- could result in unsustainable losses. Alibaba is also reportedly forcing merchants into exclusive deals: If they list their products on Pinduoduo, they could lose their listings on Tmall and Taobao. Therefore, Pinduoduo could lose a lot of merchants if it stops subsidizing their discounts.

That's why Pinduoduo's cash and equivalents plunged 75% annually to 5.53 billion yuan ($780.5 million) during the quarter. It can still fall back on its 37.05 billion yuan ($5.2 billion) in short-term investments, but it's burning cash at an alarming rate.

Pinduoduo already issued a $1 billion convertible debt offering last September to boost its liquidity and another $1.1 billion private placement in March, so investors shouldn't be surprised by more debt or secondary offerings in the future.

More subsidies during COVID-19 and rising ecosystem expenses

Pinduoduo's revenue growth was impressive since its first quarter bore the brunt of the COVID-19 lockdowns across China. However, it subsidized sales of medical supplies throughout the quarter to "counter price spikes" across the market, which helped its gross merchandise volume (GMV) more than double annually.

During the conference call, Pinduoduo's VP of Strategy David Liu declared that overall consumer demand on its platform had "not been impacted by COVID-19," and its logistics networks and supply chains "resumed at full capacity" in March.

To expand its ecosystem, Pinduoduo is pushing merchants to sell more products through its new live streaming platform, which it launched last November to counter similar services like Alibaba's Taobao Live. It's also hosting more offline events, which are promoted through its live streaming platform, to gain more shoppers. These new initiatives might expand its reach, but they could also boost its operating expenses.

An unclear outlook and a premium valuation

Unlike Alibaba and JD, Pinduoduo doesn't offer any forward guidance. Analysts expect its revenue to rise 52% this year, but for its bottom line to stay deep in the red.

Pinduoduo's stock trades at about 11 times this year's sales. By comparison, Alibaba trades at roughly 8 times this year's sales and JD has a ratio of less than 1. Both of those companies are also profitable: Alibaba trades at just 24 times forward earnings, while JD has a forward P/E of 35.

Pinduoduo is still a promising growth stock, but it doesn't deserve its premium valuation. This underdog generates robust revenue growth, but its business model is built on quicksand -- so investors should simply stick with market leaders like Alibaba and JD instead.