Pinduoduo's stock price has soared, once again surpassing Alibaba. Can the stock price continue to improve in the future?

Pinduoduo has just released its financial results for the first quarter.

Financial reports showed revenue growth of 131% and revenue growth of 202%, all of which far exceeded market expectations.

Although Pinduoduo's previous earnings also exceeded expectations, its stock price fell. The market reaction after the release of today's earnings report was lackluster.

Some factors in Pinduoduo's earnings report, such as cash flow, suggest that the quality and sustainability of the company's earnings may be poor.

In this post, I discussed why I was still optimistic about Pinduoduo before the earnings report was released, and explained why I downgraded my rating to “buy” even though I continued to be optimistic.

Pinduoduo (NASDAQ: PDD) has just released its first quarter earnings report. Earnings showed revenue growth of 131% and adjusted earnings per share (EPS) increased 202%. Both figures far surpassed analysts' expectations, and EPS in particular grew almost twice as much as expected. However, after the earnings report was released, the stock rose only slightly. As I will mention later, the lukewarm response to this explosive increase is not entirely unreasonable, as there are reasons to question the earnings figures in the report.

Market sentiment was very tense prior to the release of this earnings report. Coupled with the relatively good financial results of Alibaba (BABA), a new round of stock bull market has begun. Pinduoduo's strong financial performance also gave people hope for the continuation of this round of growth.

Despite this, although Pinduoduo's earnings are impressive, it probably won't bring about a short-term increase in stock prices. After the release of the previous earnings report, Pinduoduo not only exceeded expectations, but also far exceeded them, but the stock price continued to fall during the subsequent trading day.

Today's trading situation is similar. At the time of writing this article, Pinduoduo's stock price had risen on the same day, but it was far from the expected increase after seeing that the earnings report exceeded expectations. I think a small but positive increase is a reasonable response; although the financial data is good, as I wrote on X, investors may have doubts about the net profit figure. With TEMU losses, the company's main driver of growth, Pinduoduo's earnings grew faster than revenue growth. This situation may cause distrust among investors.

As for other people's investment suggestions: I don't recommend short-term trading on Pinduoduo, whether going long or short. Sometimes people bet on stock prices right after earnings reports are released, seeing their rise as an opportunity to make quick money. It may work sometimes, but often it isn't. Recently, the company's financial performance that exceeded expectations did not consistently predict subsequent stock performance. In my previous article on Alibaba, I mentioned that recent stock trading is based more on macro news than financial statements. Pinduoduo's performance after the release of today's earnings report seems to confirm this. Although the company surpassed expectations, its share price rose only slightly.

The last time I followed Pinduoduo, I rated it as a “strong buy” because its high growth rate indicators are very cheap. These observations are still valid: for example, the company has a PEG ratio of 0.27. However, since the last time we paid attention, Pinduoduo stock has risen 20.3% and is outperforming the S&P 500.

In the quarter just reported, Pinduoduo achieved the following results:

Revenue was $12 billion, up 131% year over year.

Operating profit was $3.59 billion, up 257% year over year.

GAAP net revenue was $3.87 billion, up 246% year over year.

Adjusted net revenue was $4.2 billion, up 202% year over year.

Adjusted earnings per American Depositary Share (EPADS) are $2.83 per share (“EPADS” is similar to earnings per share, but for American Depositary Shares (ADR)).

The data all looked excellent. Revenue and earnings both surpassed expectations, particularly earnings per share almost double analysts' expectations. However, the net outflow of the company's cash position was around $1 billion. This is probably part of the reason the trading response was lackluster after the earnings release, which I'll explore in more detail in the next section.

One of the big questions surrounding Pinduoduo's earnings release is whether these earnings data are reliable. This may be one of the reasons why stock trading reacted lukewarm after earnings were released. During the conference call, some analysts voiced concerns about this.

For example, Kenneth Fong asked how high EPS growth was achieved in the face of increased competition. If I were on a conference call, I'd also ask a related question, “Why can earnings grow faster than revenue when TEMU loses money?” This is a difficult question to explain. Fong suggests a possible explanation, and he speculates that marketing spending has been cut. This may explain the increase in earnings, but management did not confirm Kenneth's statement; it simply stated that “return on investment has been achieved in different markets.”

Furthermore, despite the high increase in earnings, the decline in cash flow has raised questions about the quality of earnings (generally, earnings are considered sustainable if supported by good cash flow, which is not reflected in Pinduoduo's recent report).

Much of the surprisingly high data is explainable. The high revenue growth is in line with Alibaba's AliExpress's increase (60%) over the same period, and the decrease in marketing spending can also explain the increase in earnings. However, the cash outflow does raise doubts about the quality of the company's earnings. Therefore, I think investors have reason to worry about whether this performance will continue.

After sharing my reaction to Pinduoduo's earnings report, we can now discuss some more long-term factors. A suitable place to start is the company's competitive environment.

Overall, competition in the e-commerce market has intensified in the past few years. In the past, Alibaba was almost the sole dominant player. Today, Alibaba, JD, and Pinduoduo are all vying for market share. As a result, the industry is more competitive than it was 10 years ago. However, Pinduoduo was only founded in 2015. Its entire growth journey and recent shift to profitability occurred during a period of increased e-commerce competition. This seems to indicate that Pinduoduo has a certain competitive advantage.

So what is Pinduoduo's competitive advantage? One significant advantage is its asset-light business model. The company has almost no inventory on its balance sheet, few fixed assets (only 2% of share capital), and very little debt (5.4% of share capital).

This lack of expensive assets and liabilities allows Pinduoduo to have more cash directly for income-generating activities: marketing, sales, and supplier recruitment. In contrast, JD and Alibaba need to deal with more debt and fixed assets.

After estimating Pinduoduo's upcoming earnings release and evaluating its competitive position, I can now do a valuation. First, let's take a look at the valuation multiples offered by Seeking Alpha Quant:

In Seeking Alpha Quant, Pinduoduo's valuation score was relatively low, only “D+.” Other multiples are quite high: for example, the net market ratio of 7.65 looks more like an expensive US tech stock than a typical value stock. However, if you look at the growth data in the chart below, you'll find that they are high enough to justify the high multiples. If Pinduoduo's high double-digit growth continues, then its price-earnings ratio of 22.75 is not too high.

Pinduoduo also performed quite well in the discounted cash flow (“DCF”) model. According to Seeking Alpha Quant, Pinduoduo's free cash flow per share over the past 12 months was $9.74. The 5-year free cash flow compound annual growth rate was 59%.

If we assume that this growth rate falls to 25% within five years (sharp deceleration), assume a terminal growth rate of 5%, and discount Pinduoduo's cash flow at a 10% discount rate, then we get a fair value estimate of $379. All of these assumptions assume that future growth will be much lower than in the past.

The 10% discount rate is also much higher than the 10-year Treasury yield (US10Y). Considering Pinduoduo's size and historical performance, these assumptions are quite conservative.

Therefore, there is every reason to believe that the future value of Pinduoduo's stock will surpass the present.

Editor's reminder: Investing is risky, and you need to be careful when entering the market. I wish everyone good luck.