When it comes to China's e-commerce market, Pinduoduo Inc (NASDAQ:PDD) is a true success story. Although Pinduoduo, also known as PDD, was founded only four years ago, the company's market capitalization of around US$40 billion is equal to that of Baidu, part of the BAT triumvirate of Chinese tech stocks that also include Alibaba and Tencent.

It currently operates an e-commerce platform based very much on social interaction but started out as a group-buying service in a similar vein to Groupon. It now believes it can disrupt the current online retail duopoly in China of Alibaba and JD.com. In fact, PDD's shares have increased over 80% from its IPO price of US$19 when the company made its debut in July 2018.

Young woman holding a smartphone and a credit card.

Image Source: Getty Images.

Fast growth in China

PDD is growing fast. For its second quarter 2019, its total sales rose 169% year-on-year to RMB 7.29 billion (US$1.1 billion). Its average monthly active users rose 88% year-on-year to 366 million while annual spending per active buyer increased 92% to RMB 1,467.5 (US$213.8).

PDD has grown quickly because China's e-commerce market is both huge and growing. According to Statista, retail e-commerce sales in China were US$572 billion in 2017 and analysts expect the market to climb to US$723 billion this year and US$940 billion in 2021.

The company is making headway via significant advertising spend. In the second quarter, PDD's sales and marketing expenses were RMB 6.1 billion, or nearly 84% of the company's total sales. To be fair, its marketing expense-to-revenue ratio is falling and will probably continue to fall as the company grows.

Key differences

PDD also does things differently versus traditional e-commerce companies like Alibaba and JD.com. The company specializes in the "team purchase model"  where users are encouraged to interact with each other to gain savings.

The platform's social nature encourages consumers to share PDD's product information on WeChat and other social networks – where if enough people buy, everyone gets a discount (which at times can be up to 90%).

Due to the social nature, people might buy items due to friends' recommendations and that then increases overall sales. The social aspect allows people to discover items that they might not have known they wanted in the first place. Like its larger e-commerce competitors, PDD's consumers can buy everything from home appliances to groceries.

Pinduoduo has doubters

Due to its discount model, the company mainly sells cheap products to lower-income shoppers, especially in China's third- and fourth-tier cities. For PDD to continue to grow and be as profitable as the market expects, it may need to gain more market share in China's top-tier (richer) cities where Alibaba and JD dominate.

Bears question whether selling low-margin products to price-sensitive customers will justify PDD's valuation – the stock trades at around 57 times forward price-to-earnings. They believe the market is currently pricing the company solely on growth, mainly because of its massive spending on marketing.

Turnin g a profit could be challenging given the competition and low margins. Once the market judges PDD on profit, management will need to execute to near-perfection.

Foolish conclusion

There is a lot to like about PDD. It has grown quickly and the company has valuable market share in China's massive e-commerce market.

For all its growth, however, management will still need to produce the future profits that the market expects – a challenge given the stock's high valuation. Management could prove the bears wrong by executing and evolving their platform to gain market share with less price-sensitive customers.

Remember that Amazon was just an online bookstore before it sold pretty much everything under the sun after that. Whether PDD succeeds in executing its vision and transforming itself within China's e-commerce landscape will determine how well its stock price does in the future.

A version of this article originally appeared on our Fool Asia site. For more coverage like this head over to Fool.hk.en.

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