Is It Too Late to Buy Pinduoduo (PDD) Stock?

Pinduoduo's (PDD -1.05%) stock surged 19% on May 26 after the Chinese e-commerce company posted its first-quarter report. Its revenue rose 58% year over year to 37.64 billion yuan ($5.48 billion), beating analysts' estimates by $920 million. Its adjusted net income grew 141% to 10.13 billion yuan ($1.47 billion), or $1.01 per American depositary share (ADS), which also cleared the consensus forecast by $0.38.

Pinduoduo is still clearly growing much faster than its two closest e-commerce competitors, Alibaba (NYSE: BABA) and JD.com (NASDAQ: JD). But is it too late to buy this stock following its 42% rally over the past 12 months?

Image source: Getty Images.

Why is Pinduoduo growing so rapidly?

Pinduoduo was founded in 2015, and it quickly gained ground against Alibaba and JD by selling discount products across China's lower-tier cities. It also encouraged its shoppers to team up through social media platforms to score bulk discounts.

Pinduoduo capitalized on that initial growth spurt to expand into the fresh produce market. But unlike Alibaba and JD, which operated their own brick-and-mortar supermarkets, Pinduoduo directly connected farmers to consumers through its own logistics network. That forward-thinking approach turned it into China's largest online agricultural platform.

After firmly establishing its position as China's third-largest e-commerce player (in terms of annual revenues) after Alibaba and JD, Pinduoduo expanded across China's more affluent cities by selling higher-end brand-name products. It also challenged Alibaba's AliExpress and ContextLogic's Wish with Temu, a cross-border discount marketplace that connects its Chinese sellers to overseas buyers.

When Pinduoduo went public in 2018, the critics dismissed it as another unprofitable Chinese e-commerce underdog to be rendered obsolete by Alibaba and JD. But here's what actually happened over the past four years.

Data source: Pinduoduo. GAAP USD terms.

Pinduoduo's revenues soared as its discount and agricultural marketplaces gained hundreds of millions of shoppers. And its margins expanded as economies of scale kicked in and it phased out its lower-margin first-party marketplace in the second half of 2021. It also likely benefited from China's antitrust crackdown on Alibaba, which forced the market leader to end its exclusive deals with merchants and rein in its aggressive loss-leading promotions.

What's next for Pinduoduo?

During the conference call, Pinduoduo's new co-CEO, Jiazhen Zhao, said the company was seeing "clear recovery trends" in China's post-COVID-19 market but admitted that it "stepped up discounts and issued extra coupons" throughout the Chinese New Year to capitalize on that rebound and fend off "intense industry competition."

That's why Pinduoduo's operating margin declined by 450 basis points sequentially (but still more than doubled year over year) to 18.4% in the first quarter. It expects that pressure to persist throughout the year as it ramps up its promotions and expands its platform with a new 10 billion yuan ($1.4 billion) "ecosystem initiative" Zhao claims will "channel more resources toward high-quality sellers" and improve its overall "service efficiency and quality."

Pinduoduo also plans to gradually expand Temu, which VP of Finance Jun Liu said was still in an "early stage" of development and only contributing a "small" amount to its top-line growth. That expansion could diversify its business away from China and enable it to compete directly against AliExpress, Wish, and Amazon in the cross-border market.

Pinduoduo didn't provide any guidance for the full year, but analysts expect its revenue to rise 30%, its operating margin to decline slightly, and its net income to grow by 6%. By comparison, analysts expect Alibaba and JD to grow their revenues by 9% and 5%, respectively, in their current fiscal years.

Is it too late to buy Pinduoduo's stock?

Pinduoduo trades at 19 times forward earnings, while Alibaba and JD have forward multiples of 13 and 15, respectively. Pinduoduo might look a bit pricier than its slower-growth rivals, but it's still cheap relative to its near-term growth.

That's probably because investors are still reluctant to dive back into Chinese stocks while they still face delisting threats in the United States. Temu's overseas expansion could also still be derailed by cybersecurity probes, outright bans (which just happened in Montana), and other escalating tensions between the United States and China.

But if you believe those tensions will eventually ease, it could be a great time to invest in Pinduoduo since it should remain the fastest-growing Chinese e-commerce leader for the foreseeable future. Its margins are healthy, its valuations are cheap, and it has plenty of room to expand its domestic and overseas businesses.