Indications that e-commerce is the next business-sector gold rush continue to grow. The ballooning of  e-commerce globally has made Amazon’s (AMZN) Jeff Bezos the world’s richest man. E-commerce is changing people’s shopping habits and with it the retail landscape. Grand View Research expects the global e-commerce market to rise at a CAGR of 14.7% through 2027.

The COVID-19 pandemic-induced lockdown has migrated even grocery shopping online. These and other factors have driven a surge in e-commerce stocks this year. Almost all e-commerce stocks are now trading at sky-high valuations. This has raised concerns regarding if the e-commerce is now overhyped and overpriced.

Pandemic or no pandemic, it likely the e-commerce trend and here to stay. Online shopping has become a way of life. The growing reach of the internet and smartphones into rural and other previously underserved areas, the rising middle class in emerging countries, and significant investment in logistics infrastructure is sure to bring more active customers to e-commerce platforms.

The risk of investing in Chinese stocks 

The next important question for investors is should they invest in Chinese e-commerce stocks? Betting on Chinese stocks could be risky because the trade and other diplomatic tensions between the United States and China continue unabated.

Adding to that tension, as the birthplace of the novel coronavirus that brought the global economy to a standstill, China’s real GDP growth is expected to slow to 1.85% this year, according to Statista. It is noteworthy, however, that global economic weakness has not impacted e-commerce growth in China, in-part because China has the world’s largest population that represents a large domestic consumer base.

Chinese e-commerce stocks have rewarded their investors for taking the country-specific risk. BABA and JD.com, Inc. (JD) dominate  the e-commerce market in China with 56% and 17% shares, respectively. But Pinduoduo Inc (PDD) and Vipshop Holdings Limited (VIPS) have entered the chase, with market shares  of 7% and 1%, respectively.

As the market leader, BABA’s growth rate has slowed. But JD and the other two stocks are relatively new and have broad scope for growth. Their growth so far is reflected in their stock prices, which has surged 75% to 285% year-to-date. But do these stocks still have the potential to grow further? To answer that, we first need to understand how to analyze e-commerce stocks.

Key metrics to consider when investing in Chinese e-commerce stocks

In the e-commerce business model, a platform generates revenue through a commission on every transaction. It is a volume-based model, with a focus on revenue rather than profits. Hence, when evaluating e-commerce stocks, one should consider three key metrics.

• Revenue growth rate
• Gross merchandise volume (GMV)
• Profit margin

E-commerce companies currently do not generate high profits, but we think their revenue growth should be on the path to generating profits in the long term. After 21 years in business, gaining a 56% market share, BABA is operating at a 35% margin.

With Chinese companies, there is another metric that should be considered: their partnerships with other tech giants in both China and the United States. I will explain this metric with company-specific examples.

Pinduoduo Inc (PDD)

PDD is a smaller company than JD in terms of revenue but has a larger market capitalization. PDD’s stock has surged 287% so far this year, hitting $179.5 billion market cap, and overtaking JD in doing so.  JD has a market cap of $132 billion after gaining 141% year-to-date.

PDD entered the e-commerce race a little late in 2015. To challenge the behemoths like BABA and JD, it had to differentiate itself and needed strong support. It adopted a mobile-first approach with a social focus. It encourages consumers to form groups and make bulk purchases to avail themselves of heavy discounts. Consumers benefit from discounts, and sellers from bulk orders.

PDD received backing from Tencent, China’s largest internet company that operates social networks like WeChat and QQ. PDD became one of the fastest-growing companies in 2018, with a revenue increase of 652% and a gross merchandise value (GMV) jump of 234%. In the third quarter, PDD’s revenue surged 89% year-over-year, but it reported an operating loss of $190 million. It will take a few years for PDD to generate any profit, which is a risk that accompanies the 280% stock price growth. Analysts expect its 2020 and 2021 revenue to surge 83% and 55%, respectively.

How does PDD stack up for the POWR Ratings?

A for Trade Grade

A for Buy & Hold Grade

B for Industry Rank

A for Peer Grade

A for overall POWR Rating

You cannot ask for better. The stock is also ranked #1 stock in the 115-stock China industry.

JD.com, Inc. (JD)

Though JD has made its mark, becoming the second-biggest e-commerce company in China after BABA, its growth rate is comparatively slower than PDD’s but higher than BABA’s. In terms of revenue, JD ($82.4 billion in 2019) is a bigger company than BABA ($72.75 billion). But it lags in market cap terms.

JD was able to challenge BABA by adopting a slightly different business model. One should think of JD as the Amazon fulfillment network of China. BABA hosts the e-commerce platform, but sellers must manage inventory. But JD goes a step further and helps third-party retailers to fulfill their orders with its network of more than 800 warehouses, fulfillment centers, and front distribution centers.

JD’s business model is capital intensive and will only deliver profits once its network reaches a large customer base and is cost-efficient. To achieve efficiency, JD is increasingly automating its fulfillment network with warehouse robots, driverless vehicles, and delivery drones.

The scale of JD’s network is attracting more customers. In the third quarter, its revenue rose 29% year-over-year as GMV and active users rose 34.8% and 32%, respectively. It reported an operating margin of 3%. It still has a long way before it reaches BABA’s level of 35% margin.

JD is benefiting from its partnerships with Tencent, Walmart (WMT), and Alphabet (GOOGL). Analysts expect JD’s 2020 and 2021 revenue to surge 37% and ~23%, respectively. JD is rated a “Buy” in the POWR Ratings. It holds straight “A” in Trade Grade and Peer Grade, and a “B” for Buy & Hold Grade and Industry Rank. It is also the #13 ranked stock in the China industry.

Vipshop Holdings Limited (VIPS)

Unlike JD and PDD, VIPS has been struggling to make its mark in the Chinese e-commerce market since 2008. It was among China’s first online flash sale marketplaces but lost to competition from BABA and JD. The turning point for VIPS came in late 2017 when JD and Tencent took a major stake in the struggling company.

JD and Tencent integrated VIPS in their marketplace. And, partly because of this, at the end of last year, VIPS sourced over 20% of new customers from JD and Tencent. In the third quarter, VIPS revenue rose 18% year-over-year as GMV and active users rose 21% and 36%, respectively. It reported an operating margin of 5.4%. Analysts expect its 2020 and 2021 revenue to surge 16% and 17%, respectively.

VIPS stock is rated “Strong Buy” in our POWR Rating system. It also has an “A” for Trade Grade, Peer Grade, and Buy & Hold Grade, and a “B” for Industry Rank. In the China industry, it is ranked #5.

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BABA shares were trading at $265.01 per share on Monday morning, down $2.24 (-0.84%). Year-to-date, BABA has gained 24.95%, versus a 16.44% rise in the benchmark S&P 500 index during the same period.

About the Author: Puja Tayal

Puja is a seasoned writer working with financial publishing companies like Motley Fool Canada and Market Realist. With over 13 years of experience in the field of fundamental research, she brings a blend of comprehensive, well-researched insights into her articles. More...

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