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Best Chinese Stock
U.S. stocks have surged in 2023 on the heels of a tech re-emergence (XLK) as the top-performing sector, +41% YTD and +30% over the last year. Although there are risks to investing in Chinese stocks, there's a substantial investment opportunity in China's market, despite a fall in investor optimism – from growth to value investing – or both!
The MSCI China Index was down 21.93% to end 2022 but is modestly up 4.71% through July 31, 2023, versus the MSCI US Index +20% for the same period. China accounts for more than 30% of the MSCI Emerging Markets Index, and although the SPDR S&P China ETF (GXC) is down nearly 8% YTD, weakening exports and manufacturing within the nation are prompting a shift in focus from growth to value as shares of popular Chinese stocks like Alibaba, Tencent, and even Pinduoduo Inc., aka, PDD Holdings Inc. (NASDAQ:PDD) have taken a hit.
In a move earlier this year to change its name and headquarters, PDD, the multinational giant offering search-based e-commerce, hopes to expand its international footprint to better rival U.S.-based Amazon (AMZN). As the political landscape in China prompted a more significant crackdown on tech stocks, since 2020, Chinese giants like Alibaba Group (BABA) and Tencent (OTCPK:TCEHY) lost nearly two-thirds of their value. Although PDD also felt the impacts and its free cash flow was negative $1B in 2021, its strategic moves and resilience have paved the way for growing free cash flows, a strengthening balance sheet, and a strong outlook for an opportunity at greater upside.
PDD stock has outperformed Alibaba & Tencent since they fell from 2021 peaks.
PDD stock has outperformed Alibaba & Tencent since they fell from 2021 peaks. (SA Premium)
As a beneficiary of the COVID-19 lockdowns, China’s 1.4B population, and one of the largest economies in the world, PDD has showcased its potential as a high-quality growth company despite the impacts of an economic downturn. PDD is a double-edged sword with a significant presence in the Consumer Discretionary and IT sectors. Within both domains, the fundamentals highlight strong growth and relative discounted valuation metrics. The re-emergence in both sectors is showcased below, offering an opportunity for investors looking for opportunities for growth and value, especially those wanting Strong Buy Quant China ADR stocks. Portfolio manager of Nous Capital China Value Fund, He Xi, states:
“During economic down cycles when everyone’s more pessimistic, investors turn to deep-value stocks, meaning stocks with relatively low valuations but with good cash flows and dividend payouts, and we’ve been seeing that in China since last year.”
MSCI Emerging Markets Index Sector & Country Weights
MSCI Emerging Markets Index Sector & Country Weights (MSCI)
Possessing nearly one billion internet users and growing, PDD shares rose nearly 12% after its second-quarter earnings results. With bullish momentum and an opportunity to seize favorable consumption trends, the Chinese company that moved to Ireland may offer investors the luck of the Irish.
PDD Holdings Inc.
Market Capitalization: $137.23B
Quant Rating: Strong Buy
Quant Sector Ranking (as of 9/5/23): 27 out of 532
Quant Industry Ranking (as of 9/5/23): 4 out of 30
I’ve written about Pinduoduo a few times, given its bullish momentum, strong growth and profitability, and relative discounted valuation. Ranked #1 in its sector and industry earlier this year, PDD was one of stocks’ biggest movers last week, beating revenue consensus and seeing a recovery in consumption. The next-level e-commerce platform experienced increases in categories like cosmetics, electronics, and handsets, which rival JD.com (JD) has a stronghold. Faster-than-expected expansion has allowed PDD to grow its differentiated products, which include a higher mix of groceries and agricultural produce. As one of the pioneers in consumer-to-manufacturing (C2M) products, PDD delivers lower costs through social contracts through Tencent’s network, resulting in lower traffic acquisition costs than rival platforms like Alibaba. With more active users than Alibaba, held in over 100 ETFs, and expected to grow by penetrating higher-priced categories, as Greenwood Investments writes, “Pinduoduo Inc. is potentially another big leader…the stock has broken forcefully out of a big multi-month base.”
PDD Stock Growth & Profitability
Offering a diversified and differentiated business model compared to its competitors JD.com and Alibaba, PDD posted consecutive earnings beats, with a stellar Q2 EPS of $1.44, beating by $0.42, and revenue of $7.18B, beating by nearly 58% year-over-year. Over the last 90 days, 19 Wall Street analysts have revised their estimates up as the company’s margins continue to expand, with a 3-5 year CAGR of +26% compared to the sector median of 11%, and its A+ Profitability Grade showcases $8.67B in Cash from Operations (TTM).
PDD Stock Growth Grade (SA Premium)
PDD’s growth and profitability are evident by its unique focus on user experiences, social media, games, and AI-driven algorithms for product recommendations and services, making it interactive. Its English-translated YouTube video asks:
“Shopping in real life is interactive because whether you’re grabbing the essentials or perusing the latest trends, you’re bound to interact with others, discover surprises, and maybe even enjoy some entertainment. So why can’t shopping online be just as fun and interactive?”
With millions of daily active users, launching promotional initiatives to encourage spending and high-quality development offers a narrow moat for the company. Research and development have been pivotal to its expansion, and improved production is aiding its manufacturing arm by delivering direct feedback for current and future products. During the Q2 Earnings Call, PDD Co-CEO Lei Chen stated:
“Since the start of 2023, our main focus has been high-quality development. The results from this quarter offer concrete evidence that our strategy is starting to bear fruit. This gives us more confidence that we are on the right path and that our investments are laying the foundation for continued quality growth…We will continue to increase our investments in R&D as innovation represents the future engine of growth for the company.”
Having experienced a fall in share price since its 2021 peak, trading above $200/per share, strong fundamentals, and a D+ valuation offer a potential buy-the-dip opportunity for this growth stock.
PDD Stock Valuation
Although PDD’s share price reflects a relative premium to the sector median, given its forward P/E ratio of 24.39x and a forward EV/EBITDA of 16.56x, its forward PEG ratio of 0.84x is more than a 41% difference to the sector.
PDD Stock Valuation (SA Premium)
Despite some lackluster valuation grades, PDD has an attractive B+ forward PEG tied to its potential growth prospects. Up 19% YTD and more than 40% over the last year, although PDD comes at a relative premium, its bullish momentum, complemented by other fundamentals, indicates opportunistic room for upside, making it an excellent portfolio consideration.
Conclusion: Should I buy Chinese stocks?
PDD Holdings is a standout amongst global and Chinese broadline retailers. It is a fast-growing massive e-commerce company with a market capitalization of +$137B. International stocks can offer diversification, and although there are some central risks to investing in Chinese stocks amid its government intervention, its move to Ireland may dispel some reservations about investing in Chinese companies.
China has the second-largest economy and largest population in the world. From a pure market size perspective, this tilts the scale from risk to reward. Considered a compelling option for portfolio diversification, this Top Growth Stock, characterized by upward analyst revisions, is a Strong Buy. Although many growth stocks were down in 2022 and market volatility poses risks, investing in Chinese stocks with excellent profitability, solid valuation frameworks, and growth prospects can prove lucrative. Consider some of our Top Rated Stocks if you're uncomfortable with international stocks. The key is to make well-informed investment decisions, using tools that help take the emotion and fear out of investing. Alternatively, if you aim to discover a select set of monthly recommendations carefully chosen from a roster of prominent quantitative stocks, you might want to delve into Alpha Picks.
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