PDD Shares Plunge: Why This Could Be a Hidden Gem for Investors

Key Points

• Shares of PDD stock are selling off to the worst day of 2024 after earnings, but the market's reaction may be unjustified.
• The company's financials show a solid quarter. China's economic recovery is underway, but Wall Street analysts still like PDD stock.
• Institutional capital flowed into PDD stock, and the market's willingness to pay a premium for this company acts as confirmation.

Warren Buffett and value investors like him like to start looking into stocks when they are beaten up the most. Value investing is often a contrarian view; otherwise, the market would be efficiently priced, as some academics would argue. Being willing to go against popular opinion and consensus can deliver the greatest dividends, and there is one stock offering such an opportunity today.

Operating China’s consumer discretionary sector, shares of PDD Holdings Inc. NASDAQ: PDD are selling off by as much as 28.5% in a single day to deliver one of the worst performances of the year. The reaction comes from the company’s second quarter 2024 earnings results, which apparently upset analysts and investors by missing expectations. The question for investors is: Did PDD underperform, or did expectations run too high?

Answering this question requires a deeper dive into the company’s financial results and a layer of confirmation through Wall Street analysts to reiterate the stock’s potential strength. Some of the downfalls have also been blamed on apparent weakness in China’s economy. This trend also begs a second look that investors can take in just a bit.

PDD's Financials Didn't Justify Today's Stock Sell-Off

Investors need to seriously consider whether a stock that delivers revenue growth of 86% over the past 12 months truly deserves to be sold off. If the real reason is missed expectations, then the conclusion might be that forecasts got too overextended, as a company with a $140 billion market capitalization delivering over 50% sales growth is not bearish at all.

More than that, operating profits grew to $4.4 billion in the quarter, representing a growth rate of 156% over the year. When operating profits accelerate faster than revenue, investors can deduce that the company is increasing its operating efficiencies through lower costs and tighter management, another bullish factor for PDD stock.

All told, net income jumped 144% in the year, which is the metric investors tend to care about the most. To keep up these growth levels, management has identified one area where they need to keep investing in the platform’s trust and safety and attract higher-quality merchants to start competing against the bigger names in the E-commerce niche.

Compared to other players like Alibaba Group NYSE: BABA, a company that is a bit bigger at $190.3 billion in market capitalization, it looks like PDD is still going through its growth phase, while Alibaba is in its mature stage of reliable free cash flows to be reinvested into further business growth.

Investors can reiterate the stage that PDD is in by checking with Wall Street analysts’ earnings per share (EPS) growth forecasts. The projection stands at 24.5% in the next 12 months, above Alibaba’s 11.4%, or even its American counterpart Amazon.com Inc. NASDAQ: AMZN, with its 22.8% EPS growth forecast.

Leaning on this superior growth and recent financial momentum, others on Wall Street had an easier time justifying their bullish views for PDD stock.

PDD Stock's Outlook Remains Bright Despite Recent Sell-Off

Now that PDD stock is trading at 61% of its 52-week high on the earnings sell-off, an opportunity for a bigger potential upside is growing. Those at Benchmark think that PDD stock should be trading closer to $230 a share, which implies a net upside of up to 134% from where it trades today.

But, these analysts weren't the only ones willing to admit that PDD stock has more upside ahead than potential downside. Bears have been reducing the stock's short interest over the past quarter, from $5 billion in net short positions to $3.9 billion.

Adding to the bullish momentum in PDD stock, portfolio managers at Tairen Capital decided to boost their stake in PDD by 49.8% as of August 2024. This increase netted their position up to $715 million today, or 0.4% ownership in the company. The evidence shows that the sell-off after earnings could be unjustified, and the stock could recover quickly.

However, Wall Street's opinion is only half the picture. The rest of the equation is solved by where the rest of the market thinks PDD stock could go, and investors can gauge the market's sentiment through valuation multiples. In this case, the price-to-book (P/B) and price-to-earnings (P/E) ratios will be used to determine sentiment.

PDD stock trades at a P/B multiple of 5.1x, above the rest of the multi-retail sector's average multiple of 2.2x. Following this trend, the P/E multiple also shows a premium valuation of 12.8x over the sector's average of 6.9x. Typically, markets always have a good reason to pay a premium valuation for a stock, and PDD's massive growth is one of them.

To prove China's fears wrong, investors can see the positive inflation rates for every month in that economy, as well as the expanding PMI index since December 2023, pointing to stronger economic activity, which eventually trickles down to the consumer.