Premium Chinese electric vehicle maker NIO (NYSE:NIO) reported second quarter earnings in early August that were remarkable and included record-high deliveries, revenues, and profit margins. Yet, NIO stock fell after the print.

Usually, when a red-hot growth stock fails to rally after a strong earnings report, that’s a sign of an extended valuation and an exhausted rally.

I think you’re getting some of that with NIO stock today. The stock has come very far, very fast, and the valuation is now quite rich. But that doesn’t mean it’s time to sell NIO stock. Rather, it just means that you need to be patient.

In the big picture, NIO is a long-term winner, supported by robust electric vehicle adoption tailwinds in China, a growing pipeline of popular cars, and strong Chinese consumer demand for luxury vehicles. Near-term valuation friction and rally exhaustion will pass. When it does, the aforementioned secular growth drivers will push NIO stock higher.

So stick with the rally. Let this choppiness play out. Buy dips. Hold for the long haul.

Here’s a deeper look.

NIO’s Strong Earnings

Don’t let the NIO stock price drop fool you. The company’s second quarter earnings report was stellar.

Total deliveries clocked in at 10,331, up 169% sequentially and 191% year-over-year. The popular ES6 continued its ramp, growing deliveries 122% sequentially to a record-high 8,068. Meanwhile, demand for the ES8 is bouncing back after the company updated its legacy model. ES8 deliveries rose by more than 1,000% sequentially to over 2,000, their best mark since the third quarter of 2019.

None of this big growth was driven by discounting. Average sales prices rose 1% sequentially to roughly $51,000. That’s the highest ASP since the third quarter of 2019.

Because growth is being driven by demand and not discounting, profit margins are roaring higher.

Vehicle margins in the quarter clocked in at 9.7%, up from -7.4% last quarter and -24.1% a year ago. Gross margins were 8.4%, versus -12.2% last quarter and -33.4% a year ago. Net loss narrowed significantly in the quarter.

NIO also received a huge injection of cash from outside investors to fortify its balance sheet. The massive cash injections also give management cushion to absorb operating losses and ammunition to invest in long-term growth opportunities.

Also of note, the highly-anticipated EC6 launched in late July, expanding NIO’s vehicle portfolio by 50% and paving the path for continued huge delivery growth in the second-half of 2020. Indeed, management is guiding for ~130% delivery growth in Q3.

All in all, it was a really solid quarter from NIO, which broadly underscored that this company is executing strongly against its huge long-term opportunity in China’s electric vehicle market.

Rally Exhaustion

Despite the great results, NIO stock failed to rally, a sign that this rally in NIO stock is exhausted. At least for the moment.

The stock has risen more than 230% in 2020, including a 250%-plus rally over the past three months. That’s a big rally in a short time. Plus, NIO stock now trades at 8-times forward sales, for a company that has yet to strike a profit.

In other words, NIO stock is a richly valued stock on the heels of a huge rally.

It’s no wonder that the market can’t find many buyers here and now. It’s also no wonder there’s plenty of sellers who want to lock in profits.

To that end, I’m not surprised that NIO stock didn’t rally after strong earnings. Nor am I worried.

This is all just near-term noise. Valuation friction. Rally exhaustion. These dynamics are ephemeral. They will pass. And when they do, the secular growth narrative of NIO turning into the dominant premium luxury electric vehicle brand in China will power shares higher over the next five to ten years.

Big Long-Term Potential

Longtime readers of mine know the basic constructs of my NIO model. China’s auto market will remain the biggest in the world for the foreseeable future (20+ million passenger cars sold per year), growing slightly over the next several years due to population growth and urbanization trends. Electric vehicle penetration in that market will soar towards 30% in 2030, implying somewhere around 8+ million electric vehicle sales by the end of the decade.

The luxury vertical in that EV market will be big — around 10% — mostly because Chinese consumers have an affinity for luxury vehicles. Within that luxury vertical, NIO will grab about half of the market, leveraging branding, technology, production, and “home town” advantages to beat out other players in the market.

On those assumptions, I’ve long stated that NIO has $1.50 earnings per share potential by 2030. I’m revising that upwards to $1.85, mostly because strong second quarter earnings give me greater confidence that NIO can sustain higher-than-expected ASPs on its cars due to strong Chinese consumer demand for premium EVs, which will lead to higher revenues and bigger gross margins at scale.

Based on a 17-times forward multiple and an 8.5% discount rate, that implies a 2020 price target for NIO stock of $15 and a 2029 price target of over $30.

Bottom Line on NIO Stock

NIO stock is a long-term winner. Second quarter earnings confirmed as much.

So don’t pay too much attention to this post-earnings sell-off in NIO stock. The stock is just temporarily exhausted and running into some near-term valuation friction.

Let these headwinds induce some profit taking. Let the stock chop around, then buy the dip and hold for the long haul. Because long term, this stock is only going higher.