Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) frequently dominate conversations about China's rapidly growing e-commerce sector.

However, investors shouldn't overlook growing underdogs like Pinduoduo (NASDAQ:PDD) and Vipshop (NYSE:VIPS). Pinduoduo controlled 13.2% of China's e-commerce market in 2021, according to eMarketer, putting it in third place behind Alibaba (47.1%) and JD (16.9%). Vipshop ranks fifth with a 1% share.

Let's take a closer look at Pinduoduo and Vipshop, and see which company will generate bigger gains if the regulatory headwinds facing Chinese stocks finally wane.

Tiny parcels on a laptop keyboard.

Image source: Getty Images.

The differences between Pinduoduo and Vipshop

Pinduoduo, which was founded in 2015, differentiated itself from Alibaba and JD with three main strategies. First, it encouraged shoppers to team up on bulk purchases to secure bigger discounts. Second, it aggressively targeted China's lower-tier cities with cheaper generic products instead of brand-name goods.

Lastly, Pinduoduo expanded its agricultural network by enabling farmers and local grocers to directly sell their fresh produce to shoppers at lower prices.

Vipshop, China's first major flash sale marketplace, was founded in 2008. Alibaba's subsequent rollout of flash sales on Taobao and Tmall throttled Vipshop's growth in the mid-2010s, but JD and Tencent (OTC:TCEHY) breathed fresh life into Vipshop's struggling business with new investments and partnerships in 2017.

JD integrated Vipshop's flash sales into its own marketplace, while Tencent integrated Vipshop's marketplace into WeChat, China's top mobile messaging platform with over 1.25 billion monthly active users. Those partnerships kept Vipshop relevant and turned it into a major player in the growing "social commerce" market.

Pinduoduo and Vipshop will both likely benefit from the Chinese government's antitrust ruling against Alibaba, which forces it to discontinue its exclusive deals with merchants. However, Pinduoduo and Vipshop were also struck with smaller fines earlier this year after regulators scrutinized their aggressive pricing strategies.

Pinduoduo's fundamentals are improving

Pinduoduo's revenue surged 97% to 59.5 billion yuan ($9.1 billion) in 2020 as the pandemic drove more shoppers online. It also continued to expand its agricultural network and partnered with more brand name merchants to challenge Alibaba and JD across China's higher-tier cities.

But those expansion efforts, which relied heavily on aggressive marketing campaigns and subsidies, were very expensive. Its net loss widened from 7.0 billion yuan in 2019 to 7.2 billion yuan ($1.1 billion) in 2020.

In the first half of 2021, Pinduoduo's revenue skyrocketed 141% year over year to 45.2 billion yuan ($7.0 billion). It benefited from an easy comparison to the pandemic's initial impact a year ago.

The company ended the second quarter with 738.5 million monthly active users, up 30% from a year earlier. Its number of annual active buyers over the past 12 months rose 24% year over year to 849.9 million.

Pinduoduo also narrowed its net loss year-over-year, from 5.0 billion yuan to 491 million yuan ($76 million), in the first half of 2021. For the full year, analysts expect its revenue to rise 82% to 108 billion yuan ($16.7 billion) with a narrower net loss of 3.8 billion yuan ($590 million).

Vipshop generates slower and steadier growth

Vipshop's revenue increased 10% to 101.9 billion yuan ($15.6 billion) in 2020, and its net income grew 47% to 5.9 billion yuan ($905 million). On an adjusted basis, its net income rose 25% to 6.3 billion yuan ($961 million).

In the first half of 2021, Vipshop's revenue rose 35% year-over-year to 58 billion yuan ($9.0 billion). Its net income increased 19% to 2.6 billion yuan ($400 million).

Vipshop ended its second quarter with 51.1 million active customers, up 32% from a year earlier, as its total orders grew 30% to 221.5 million. Its number of "Super VIP" members, who pay subscription fees for extra discounts and perks, grew nearly 50% year over year and accounted for roughly a third of its gross merchandise volume.

Analysts expect Vipshop's revenue to rise 19% to 121 billion yuan ($18.8 billion) this year, but for its adjusted net income to dip 15% to 5.4 billion yuan as it ramps up its spending on new marketing campaigns and its Super VIP platform.

The valuations and verdict

Pinduoduo trades at seven times this year's sales, which makes it much cheaper than other tech stocks with comparable growth rates. Vipshop's stock looks even cheaper at 2.5 times this year's sales and eight times next year's earnings.

Both stocks are depressed by the same regulatory headwinds that are battering Alibaba, JD, and other Chinese tech stocks. But if you're willing to ride out that storm, I believe Pinduoduo's higher growth rates, more diversified marketplace, and larger user base make it a much better overall investment than Vipshop. Vipshop's business is stable, but it won't attract as much attention with its slower growth rates.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.