Don’t let the sheer scope of the sell-off deter you. The market’s overreacting to management’s cautious language regarding the future.
It’s been a tough past few days for PDD Holdings (PDD 2.88%) shareholders. The stock tumbled to the tune of 28% on Monday — it’s biggest-ever single-day setback — following the release of its disappointing second-quarter results and alarming guidance. Shares have continued to fall since then, too. All told, PDD stock now sits more than 40% below its August peak.
Rather than fearing the prospect of further downside, risk-tolerant investors might want to use this extreme weakness as a buying opportunity. The market is overreacting to the wording of the company’s admittedly dire warning. Most investors are also underappreciating how growth-measurement figures can be misleading for high-growth outfits like this one.
PDD Holdings spooks investors
On the off chance you’re reading this and aren’t familiar with the company, China’s PDD Holdings is the e-commerce company formerly known as Pinduoduo. You, however, may be more familiar with its presence outside of China. This is the parent to online-shopping platform Temu (although it still operates as Pinduoduo in China), which connects manufacturers directly with consumers, thus bypassing the need for middlemen and distributors.
The quarter in question wasn’t a bad one. Revenue of nearly $13.4 billion was up 86% year over year, leading to a 156% improvement in operating income during the three-month stretch ending in June. But analysts were looking for a slightly bigger top line.
Perhaps the crux of the post-earnings sell-off is the cautious outlook the company added to its Q2 report. Vice President of Finance Jun Liu said: “In the past quarter, our revenue growth rate slowed quarter-on-quarter. Looking ahead, revenue growth will inevitably face pressure due to intensified competition and external challenges.” She adds that “Profitability will also likely to be impacted as we continue to invest resolutely.”
The clincher is CEO Lei Chen’s comment: “We are prepared to accept short-term sacrifices and potential decline in profitability.”
Yikes. Even without any real clarity as to what the warning means in practical terms, phrasing like “intensified competition” and “decline in profitability” paint an alarming picture. Investors understandably flinched.
The problem is, the market may be reading more into the matter than is merited.
Better than believed
Don’t misunderstand. Liu and Chen are clearly trying to keep investors’ expectations in check and perhaps even trying to tamp down those expectations. Do take the hint.
But also keep things in perspective. It’s not as if PDD has entered markets that weren’t already chock-full of competition. The company has been able to penetrate them anyway with its unique factory-to-consumer service. Spending heavily to drive this growth has been worth it and isn’t exactly a new development. The company’s direct-to-consumer business, in fact, has still only scratched the surface of its ultimate opportunity. That’s connecting China’s manufacturers with North American consumers. And Temu is outgrowing its rivals in the sliver of this market where the most growth awaits. Whatever other spending is in the cards will likely be worth it in the long run.
In the meantime, the company’s warning that “revenue growth will inevitably face pressure due to intensified competition and external challenges” is doing even more damage than it should, leading investors to think a weakening economy is crimping consumers’ capacity to spend. It isn’t.
There are red flags to be sure. Household debt within the United States continues to rise, according to data from the Federal Reserve, with credit card and auto loan delinquencies still elevated as of Q2. China’s real estate market is still on the defensive as well. These are anything but signs of economic strength.
Look at all the data though. Retail sales in the U.S. improved 2.4% year over year in June, extending a lengthy growth trend. China’s retail spending grew 2.7% in the same month, marking the 19th consecutive month the nation’s consumers spent more than they did in the same month a year earlier.
US Retail Sales data by YCharts.
The economic future doesn’t exactly look grim either. As interest rate cuts loom against a backdrop of finally easing inflation, the International Monetary Fund (IMF) is calling for full-year global GDP growth of 3.2% this year to accelerate to a pace of 3.3% next year. The IMF specifically highlights Asia’s emerging markets as leaders and drivers of this growth, with China’s 2024 GDP growth likely to roll on at 5.4% this year, followed by a still-impressive pace of 5.1% next year.
That’s an obvious growth slowdown, but like PDD’s revenue, this slowdown is largely the result of ever-rising comparison figures. A slowing pace of comparative growth doesn’t inherently mean absolute growth is slowing.
Not for everyone, but now’s the time if it’s for you
PDD Holdings still isn’t the right kind of pick for everyone. Only risk-tolerant investors should consider taking on a stake, and even then, any trade in Temu’s parent should be well monitored and relatively small.
Nevertheless, the market is clearly overreacting to PDD’s recent revenue shortfall and warning of impending pressures on its profitability. One also has to wonder if this stock was headed into Monday’s earnings report already unfairly vulnerable to the slightest whiff of trouble.
Whatever the case, the sellers overshot their target. Even if a little more downside is in store due to the stock’s current bearish momentum, it wouldn’t be crazy for risk-tolerant growth investors to start tiptoeing into a position here.