2 Big Risks You Should Know About Before Investing in Pinduoduo

Here are two key risks for investors thinking about buying shares of China’s hot e-commerce company Pinduoduo Inc (NASDAQ: PDD). – Danger avoid headwind

Pinduoduo Inc (NASDAQ: PDD) is a leading e-commerce company in China alongside Alibaba Group Holding Ltd (NYSE: BABA) (SEHK: 9988) and Inc (NASDAQ: JD).

The company has seen its share price more than double to US$85 over the last 12 months. Pinduoduo’s strong stock price performance might have enticed investors to buy its shares.

Still, I think there are key risks that investors should know about the company before investing their hard-earned money in it. Here are two of them.

1. Resignation of founder

Founded in 2015, Pinduoduo rose to become the second-largest e-commerce company in China (in terms of monthly active users).

During that period, revenue grew from nothing to RMB 37 billion (US$5.41 billion) thanks to its meteoric rise in gross merchandise value (GMV). Its GMV reached RMB 1.3 trillion for the 12 months ended 30 June, 2020.

One of the main reasons that drove Pinduoduo’s success is the company’s founder; Huang Zheng. Trained as a data scientist, he began his career in Google and was part of the team that established Google China.

Before Pinduoduo, he had already founded two companies:  an e-commerce platform and a gaming studio. This multidisciplinary experience, in my opinion, contributed significantly to the success of Pinduoduo.

In addition to offering technical expertise, Huang Zheng has been the promoter of its core value, 本分 (Ben Fen). This means to “adhere firmly to one’s own duties and principles”. I feel this was key in providing the foundation for Pinduoduo to scale its enterprise.

Hence, Huang Zheng’s decision to step down as CEO, and later the chairman post, is a factor that investors should consider when evaluating Pinduoduo’s prospects going forward.

On a slightly positive note, Huang Zheng continues to work closely with the board and management to explore the company’s future strategic direction and organizational structure.

This is despite the fact that he has taken a step back from the day-to-day management responsibility as a CEO.

2. Valuation

The other risk that investors should consider before investing in Pinduoduo is its steep valuation. There are many ways to look at this.

To start with, PDD is a loss-making business and cannot be valued using the traditional price-to-earnings (PE) ratio.

Similarly, price-to-book (PB) ratio is useless here since the company operates an asset-light model that will render its PB ratio irrelevant.

Hence, we will use the price-to-sales (PS) ratio to offer us some perspective. At today’s (at the time of writing) price of US$85, Pinduoduo is trading at a PS ratio of about 19x!

Personally, I think the valuation is very high, even considering all the positive attributes of the company. Hence, buying Pinduoduo’s stock today provides no margin of safety for investors.

Foolish takeaway

Overall, I think Pinduoduo is a good stock that investors should learn more about thanks to its solid growth track record and positive ongoing prospects.

Still, investors should not ignore the risks associated with this investment (discussed above) and should exercise caution when investing in this stock.

More reading

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Lawrence Nga doesn’t own shares in any companies mentioned.

The Motley Fool Hong Kong Limited( 2020

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