What happens to Pinduoduo’s stock?

It’s been a turbulent week for Pinduoduohis (PDD 0.67%) investors. Despite reporting an 86% increase in its top line in last quarter’s earnings, the leading e-commerce platform saw its stock drop more than 30%.

Investors were unimpressed by the strong numbers and instead focused on Pinduoduo’s warning of slower growth going forward. But is the situation that serious? Let’s explore this further.

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Pinduoduo performed at a world level

Pinduoduo was one of the most remarkable success stories of the decade in the Chinese technology industry. Established in 2015, it came from nowhere to become a giant to challenge the incumbents Alibaba and JD.com. In less than 10 years, the e-commerce company has achieved $34.9 billion in revenue and $8.5 billion in net profit by 2023.

But despite its massive size, Pinduoduo has continued to grow at a high double- to triple-digit rate in recent quarters. In the second quarter of 2024, revenue rose 86% to $13.4 billion, while net profit doubled to $4.4 billion. A steadily growing Chinese business and the recent expansion of cross-border e-commerce through Temu drove growth.

In particular, Pinduoduo’s continuous focus on developing its ecosystem, better services, and providing value to customers has kept users coming back for more. The company also benefited from operating leverage as its fixed cost is growing much slower than its top line expansion.

It’s also worth pointing out that Pinduoduo has maintained a solid (and growing) cash hoard despite its amazing growth rates. By the end of the second quarter of 2024, it had $39.2 billion in cash, cash equivalents and short-term investments with minimal debt.

In other words, Pinduoduo has demonstrated a rare combination of growth, profitability and a solid balance sheet.

However, management’s tone on the outlook was pessimistic

Most companies prefer to highlight their strengths and bright spots while avoiding or hiding their shortcomings. But that is not the case with Pinduoduo. The tech giant has warned investors many times in the past that its quarterly earnings will fluctuate and they shouldn’t extrapolate its recent earnings into the future.

Last quarter, the company went even further in highlighting the risks it may face going forward. Lei Chen, president and co-chief executive officer of Pinduoduo, focused almost exclusively on the challenges in the company’s latest earnings note: “While encouraged by the solid progress we’ve made in recent quarters, we see many challenges in future”. These are his opening remarks in the earnings release, despite posting a 144% increase in net profit.

In the earnings call, Chen discussed increasing competition, planned massive investments to grow its ecosystem, and the inevitable decline in profitability going forward. In layman’s terms, growth will be more difficult to achieve and profitability will decline in the future for its China business. Similarly, Chen said Temu faces an increasingly competitive environment and other non-commercial challenges, further dampening investors’ hopes that Temu could help support Pinduoduo’s hypergrowth rates.

Additionally, management has ruled out returning capital to investors in the form of dividends and share buybacks for the next several years. This was probably the straw that broke the camel’s back, causing many investors to exit the stock.

What it means for investors

Pinduoduo’s remarkable growth over the years has turned it into a giant that rivals its biggest peer, Alibaba. The downside is that size will naturally hinder future growth. After all, no company can sustainably grow at 86% forever.

The silver lining is Pinduoduo has recognized this and is doing everything it can to keep its growth machine running. This includes investing in developing its ecosystem, supporting quality merchants, and improving trust and security.

These investments, although expensive, are likely to lead to more sustainable development in the long term.