JD: Expensive, But Worth It

About: JD.com, Inc. (JD)
by: Mauro Solis

JD could be overvalued by as much as 83%, but the long-term returns make it worth the risk.

The earnings growth JD could have with as little as 20% revenue growth should compensate for the high price Tag.

The partnership with Google might pay off.

JD.com (NASDAQ:JD) is expected to deliver robust revenue growth next year and keep growing exceptionally well in the following years. Investing in the company presents a safe risk-reward proposition with a dream-come-true downside and powerful upside potential, and as for its price, it is terribly overvalued.

JD is a large-cap company with a market cap of about $45 billion in market cap and good financials.

What makes it different

One of the things that brought attention to the stock is the disclosure that Michael Burry added a position in the stock. Besides that, JD is investing heavily in data analytics, where it might have a powerful ally.

JD has partnered with Google (NASDAQ:GOOG) (NASDAQ:GOOGL) on many fronts - in June of last year Google invested over half a billion in JD stock - to develop better retail infrastructure and boost the selection of JD.com items on Google Shopping. Recently JD started selling goods to American customers via Google's shopping platforms.

Source: MarComm News

Now that JD and Alibaba (NYSE:BABA) are racing to the analytics market, JD could leverage its partnership with Google to outperform Alibaba, or at least boost its growth significantly. The program that JD is advancing is called A100, and among its clients are Nestle (OTCPK:NSRGY), Procter & Gamble (NYSE:PG) and Kimberly-Clark (NYSE:KMB). An impressive roster that already shows JD is more than capable of delivering remarkable results and leverage its core business.

Just like AT&T (NYSE:T) is leveraging its content and client relationships and created its advertising and analytics business, JD's step toward analytics brings a sea of opportunity with little downside.


Assuming revenue growth could range between 13.3% and 36%, that gross margin could vary between 14.8% and 14.8%, R&D as a percentage of revenue is in the range of 2.3% and 1.6%, G&A as a percentage of revenue probably will oscillate between 12.5% and 11.8%, we have the following chart:

Source: Author's Charts

The revenue projection is in line with what the market expects for JD in the next couple of years, as the image below shows.

Source: Seeking Alpha

I like to use Peter Lynch's ratio when valuing a stock. This method uses the ratio between the expected earnings growth plus dividends and the P/E of the stock to determine its fair value. A stock that has a 1:1 ratio is reasonably priced. The higher the number, the more underpriced the stock is.

Source: Author's Charts

Constructing an adjusted Beta-PERT risk profile for the long-term prospects of the stock, we can calculate the risk profile for the company:

Source: Author's Charts (Long Term)

The risk profile shows there is an 8% probability that JD will trade at a lower price than it is today. The upside could be up to 63.57% yearly return.

Building an adjusted Beta-PERT risk profile for the current fair price of the stock, we can calculate the risk profile for purchasing the stock now.

Source: Author's Charts (Short Term)

The risk profile shows there is a 92.74% probability that JD will trade at a lower price than it is today. Considering the potential downside, upside and the likelihood of each, the statistical value of the opportunity of investing now is of -50.8%

Source: Author's Charts

Let's explain in greater detail the statistical value of the opportunity to invest in a company. The statistical value is the sum of all the possibilities that an event or a proposition have multiplied by their respective output.

Betting heads on a coin flip, where if you win, you will get 100% return, but if you lose, you would lose 100%, has a statistical value of 0%. If someone were to bet an infinite number of coin flips, they would end up with the same money they began.

On the other hand, if the odds of the coin flip were heads, you win 200%, and tails, you lose 100%, the statistical value of the bet would be 50%.

In this particular case, the short-term statistical value of the stock is -50% while the long-term prospects for the stock represent a mathematical value of 29%. Which is a very fancy way of saying that the stock is drastically overvalued for its current results, but could become grossly undervalued in the future and a home-run stock.


JD's analytics could deliver a significant result for the stock and move the price considerably, but even if this doesn't happen, the core business is favorable, and although the current price is dreadfully overvalued, the likely future growth in earnings makes it worthwhile to take it now at such a high price.

In a past article, I explained why stocks with high earnings growth that are fairly priced give a higher return than stocks that have lower earnings growth, and so in the market, top growth stocks tend to trade above their fair price.

In the case of Netflix (NASDAQ:NFLX) for instance, it is trading so far from its fair price that the chances are slim that it can deliver the results that would justify its price. JD is the opposite. Its current price might be scarily high, but it is quite possible that it will be able to deliver a strong enough result to justify a much higher price in the future.

Given the robust growth in revenue that the company has shown in the past, the acceptable financials and the quaint level of debt that the company has, it is probably a good idea to get JD. Because of the short-term risks, a half position might be the best choice; "it is not wise to test the water with both feet" as my grandmother says.

The company has done a fantastic job, and the service it provides is astounding. Sure, there are some risks, but the long-term prospects of the company make up for the exposure.

If there is anything in this article, you agree or disagree with or would like me to expand further on, I would sincerely appreciate you leaving a comment. I will address it as soon as possible.

Disclosure: I am/we are long JD, GOOG, GOOGL, T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.