The last few years have been difficult for Chinese companies, with top companies like Alibaba and Tencent seeing significant drawdowns in their share prices. This contrasts with its U.S. counterparts, which have been reaching new highs. For perspective, the Nasdaq Composite reached a new all-time high in 2024.
While most investors shy away from Chinese companies, contrarian investors are excited about Chinese tech companies, thanks to their lower prices. Among them is JD.com (JD -0.22%), a leading e-commerce company in China. Down more than 70% from its peak, JD looks like a tremendous bargain right now.
Still, investors shouldn't rush into JD's stock until they consider the following risks.
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The Chinese e-commerce market is highly competitive
JD appeals to investors because of its leading position in the largest and still growing e-commerce market. For starters, the company operates under a similar business model to Amazon, with a massive first-party business complemented by its third-party marketplace. It also owns its logistics company, allowing it to deliver products to customers quickly and cheaply.
Unlike its peer in the U.S., however, JD's competitive position in the market has always been the second(and now probably third) most significant player by size. In the early days, JD had to compete mainly with Alibaba to grow its market share. In recent years, however, competition has intensified as latecomers like PDD Holdings (NASDAQ: PDD), known more commonly as Pinduoduo (the name of its platform and previously the company’s name), and Douying are gaining market share at the expense of the incumbents.
These latecomers became successful as they leveraged new technologies and business models to delight their customers. For instance, Pinduoduo leveraged the smartphone and its group-buy business model -- consolidating multiple orders before buying bulk from factories to get rock-bottom prices -- to grow its reach in rural areas. Douying, on the other hand, leveraged its short-video platform, giving it an edge on customer acquisition, to provide live-streaming e-commerce services.
While JD has had a good head start and built competitive advantages in economies of scale, thanks to its integrated business model, it wasn't enough to prevent these new players from gaining scale and market share. The ongoing changes in consumer behavior and the unmet demand -- China has a vast and growing retail market -- make it difficult for any player to dominate. Even e-commerce giant Alibaba has had trouble maintaining its market share lately.
The intensified competition is clearly reflected in JD's recent financials, where revenue growth fell to a low of 4% in 2023. JD used to grow at double digits in the earlier years. By comparison, Pinduoduo's revenue jumped 90% in 2023.
For JD to regain its place in investors' limelight, it must demonstrate its ability to compete (and succeed) in defending its market share. The company has been working on strategies like low prices and better services to attract and retain users. Investors can keep an eye on the impact of these efforts on JD's market share in the coming quarters.
Investors are pessimistic about Chinese companies for good reason
Once an attractive developing market for global investors, China has become a difficult (if not impossible) market for most U.S. investors to participate in, due to the growing risks in recent years. Topping the list is the political and regulatory risks that investors must endure.
As the Chinese government exerts substantial control over the economy, it can (and will) implement policies that it deems to be in the interest of the nation, party, and society, even if those policies come at the expense of industries and companies. The recent crackdowns on technology, private education, and real estate sectors are classic examples of what could happen to companies if they don't fit into the government's long-term direction.
Besides, the cultural and governance differences between the Middle Kingdom and the West have also become unbearable for most investors. Some ongoing issues, such as limited disclosures, opaque accounting practices, and generally weak management practices, make future predictions extremely difficult for most Chinese companies.
Beyond that, ongoing tensions between China and major economies like the United States can lead to trade disputes, tariffs, and sanctions that directly impact the profitability and operations of Chinese companies. The ban on Huawei and the recent decision for TikTok to sell its operations or face a ban are examples of what could happen to Chinese companies.
With no end in sight for these issues, investors looking to buy Chinese stocks like JD have no choice but to accept these risks. Understandably, many are unwilling to do so, which explains the poor demand for Chinese stocks in the last few years.
What it means for investors?
After reaching its all-time-high price in 2021, JD's stock has gone nowhere but down. Its poor stock performance, however, means that the stock is trading at an extremely attractive valuation. JD has a price-to-sales (P/S) ratio of 0.3, a massive discount from its five-year average of 0.99.
Still, just because the stock is cheap doesn't guarantee good investment returns. Unless JD demonstrates good progress in defending its e-commerce market share or the overall perception of the risk of owning Chinese stocks improves, JD stock could remain a value trap for a long time. If that's the case, owning the stock will come at a huge opportunity cost, even if the stock price doesn't fall further.
