3 Reasons to Buy JD.com, and 1 Reason to Sell

JD.com's (JD 2.47%) share prices rose 3% on Aug. 23 after the Chinese e-commerce giant posted second-quarter numbers that surpassed analysts' expectations on the top and bottom lines.

However, China's unpredictable crackdown on its top tech companies has still caused JD's stock price to decline roughly 30% from its 52-week high. Is the stock worth buying as those headwinds depress its valuation?

Let's examine three compelling reasons to buy JD stock -- as well as one reason to sell it -- to decide.

Image source: JD.com.

1. What pandemic-related slowdown?

Many e-commerce companies that experienced accelerating sales growth throughout the pandemic now face difficult year-over-year comparisons as the public health crisis begins to come under control and more businesses reopen.

However, JD's Q2 revenue rose 26% year over year to 253.8 billion yuan ($39.3 billion), beating analysts' estimates by $1.1 billion. Its annual active customers increased 27% to 531.9 million.

That represented a slight slowdown from the first quarter, but it was still impressive when we consider how rapidly it grew in the prior-year quarter:

Data source: JD.com. Growth is on a year-over-year basis. *Revenue change is measured in RMB terms.

JD attributed its robust growth to its annual 618 shopping holiday in June, deeper partnerships with overseas brands like LMVH's Bulgari and Guerlain, and its expansion across China's lower-tier cities, which accounted for nearly 80% of its new users during the second quarter and more than 70% of its total active users over the past 12 months.

2. Stable margins at its core business

JD's non-GAAP net income declined 22% year over year to 4.6 billion yuan ($0.7 billion), or $0.45 per American depositary share, which still beat estimates by $0.11 a share.

JD's net income fell because it ramped up its logistics investments and faced tough comparisons to the prior-year quarter when it reined in its marketing expenses and benefited from a temporary government-mandated reduction to its social security contributions for employees. As a result, JD's total non-GAAP operating margin fell 118 basis points to 1%.

However, JD Retail's operating margin actually held steady year over year at 2.6%. Excluding its benefits in the prior-year quarter, JD Retail's operating margin actually expanded on a comparable basis, thanks to its scale, the efficiency of its first-party logistics network, and the expansion of its higher-margin third-party marketplace. That stable margin indicates JD still has plenty of pricing power against Alibaba (BABA 1.82%) and Pinduoduo (PDD -0.99%) in China's crowded e-commerce market.

3. It's cheap relative to its growth potential

Analysts expect JD's revenue to increase 29% this year, but project its non-GAAP net income will decline 49% as it ramps up its spending again. But next year, they expect its revenue and net income to rise 22% and 104%, respectively. 

Investors should be skeptical of those estimates, but they indicate JD's stock trades at less than one times its annual revenue. By comparison, Alibaba and Pinduoduo -- which also stumbled during the Chinese tech sell-off -- trade at three and six times this year's sales estimates, respectively.

The one reason to sell JD.com: Regulatory uncertainties

JD hasn't been hit by an antitrust probe or a record fine like Alibaba yet, but China's State Administration of Market Regulation (SAMR) still levied minor fines against JD over the past year due to its pricing strategies, misleading advertisements, and other antitrust violations.

As China's largest direct retailer, JD remains exposed to new antitrust laws. China's new data protection laws, which will go into effect on Nov. 1, could also curb JD's ability to gather data from its customers.

Chinese and American regulators have also been scrutinizing the variable interest entity (VIE) structure, which enables Chinese companies to list shares of overseas shell companies in the U.S., and closing that loophole could delist most Chinese stocks. To top it off, a new U.S. law could delist shares of Chinese companies that don't comply with new auditing standards within the next three years.

All of those unpredictable regulatory headwinds make it tough to buy JD or any Chinese stock -- regardless of how attractive their fundamentals and valuations might look.

Should you buy or sell JD?

I sold nearly two-thirds of my JD shares earlier this year to reduce my overall exposure to Chinese tech stocks. However, I plan to hold on to my remaining shares and see if the regulatory headwinds wane.

JD's fundamentals look strong, but I don't think it's the right time for new investors to hop in yet. Instead, investors who are looking for high-growth e-commerce stocks in emerging markets should stick with Sea Limited or MercadoLibre instead.