Down 17% in a week and on a P/E of 10! Should I buy this dirt cheap value stock?

Chinese stocks are normally valued at a discount to their US peers, even if they’re in hyper-growth mode. Take PDD Holdings (NASDAQ: PDD), which is a Chinese e-commerce company that trades at the sort of valuation you’d expect to see from a FTSE 100 value stock.

The Temu owner grew its revenue and earnings by 59% and 78%, respectively, last year. Yet the stock has tumbled 17% in a week and now trades at a price-to-sales (P/S) ratio of 2.6 and a price-to-earnings (P/E) multiple of just 10.5.

At first glance, this looks unjustifiably cheap. So, should I add this value stock to my portfolio? Let’s find out.

Chinese stocks

Firstly, it’s worth pointing out why US-listed Chinese stocks trade at such a wide discount to American peers. It all boils down to regulatory risk, as China’s tech companies can quickly fall foul of regulators and have them breathing down their necks for all sorts of reasons.

For example, as well as its international Temu shopping platform, PDD operates Pinduoduo in China. It focuses on value-for-money merchandise and has a strong emphasis on agricultural products, directly connecting farmers with consumers. It has had great success taking market share from larger e-commerce rivals like Alibaba in recent years.

However, President Xi Jinping wants more “high-quality development” in the Chinese economy, with fewer counterfeit goods. In response to these concerns, Pinduoduo has initiated efforts to enhance product quality. Last year, PDD said it was “prepared to accept short-term sacrifices” to “vigorously support high-quality merchants“.

I read this as a clear signal that the firm’s profits were going to come down significantly. To be fair, management was honest about this, saying: “In the long run, the decline in our profitability is inevitable”.

Essentially, Chinese companies have to align themselves with what the government wants. And this often doesn’t involve the maximisation of shareholder profits, which puts off a lot of investors.

Hence why most Chinese stocks trade at cheap multiples. And geopolitical risk associated with US-China tensions only adds to the downwards pressure.

From billionaire to millionaire

But it’s not all domestic issues, including weak Chinese consumer spending, for PDD. Temu’s explosive growth has relied on shipping low-cost goods to US consumers directly from Chinese merchants.

However, President Trump has abolished the de minimis tax exemption that encouraged this, as well as slapping sky-high tariffs on Chinese imports. In Q1, PDD’s revenue grew just 10% to $13.2bn, a significant deceleration. Meanwhile, profits fell nearly 50% to $2bn!

The risk here is that Temu users face paying far higher costs, which could undermine the platform’s raison d’être (dirt cheap bargains). Instead of being able to “shop like a billionaire“, as Temu puts it, consumers might have to settle for shopping like a humble millionaire. Or not at all on the app.

Should I buy shares of PDD?

Given the significant challenges the company faces, I don’t think the earnings figures can be relied upon. In other words, the P/E ratio of 10 might be misleading if growth decelerates and margins take a hit.

If a US-China trade deal is struck, perhaps PDD’s strong international growth might resume. But given the murky outlook, I’m going to focus on other growth stocks for my portfolio.

The post Down 17% in a week and on a P/E of 10! Should I buy this dirt cheap value stock? appeared first on The Motley Fool UK.

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Ben McPoland has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.