In April 2020, I wrote that Nio (NYSE:NIO) stock has “the potential for tremendous long-term gains.” Now, 17 months later, that thesis certainly proved to be true given the stock is up 1,220% from the day that story was published.
Unfortunately, the Nio stock story has changed so far in 2021. Shares are down 28% year to date, including a 25% drop in the past two months alone.
I still like Nio as a company and believe there is significant upside for the stock in the long term. However, traders that are buying the dip in Nio stock today are facing at least three risks that they weren’t facing in the spring of 2020.
Nio Stock Can’t Afford A Chinese Economic Crisis
Last week’s major selling pressure in the U.S. market stems from liquidity issues with China’s largest property developer, Evergrande. Most experts seem to think China’s government can and will step in to act aggressively and stabilize Evergrande. They are betting China can prevent an economic crisis. But others believe there may be more near-term risk to the Chinese economy than people realize.
“This liquidity issue — real estate is so important to the Chinese economy and the financial well-being of so many Chinese families,” says Jimmy Chang, chief investment officer at Rockefeller Global Family Office.
“So many people buy apartments as an investment, so if this thing is not contained, it could become a real black swan.”
But even before the Evergrande issues, cracks were forming in China’s economy. Earlier this month, Fitch Ratings said China’s economy has “lost momentum” in recent months. Fitch also warned that China may not hit its targets of 8.4% GDP growth in 2021 and 5.5% growth in 2022.
A big part of my recommendation of Nio stock as a “lottery ticket” speculation in early 2020 was the Chinese economy. China insulates its domestic companies from international competition. And Nio is a way for U.S. investors to bet on the largest emerging market in the world. But if China’s growth slows or Evergrande triggers an economic crisis, Nio stock is likely going down with the ship.
Regulatory Crackdowns
The risk to buying Nio stock in early 2020 mostly had to do with Nio’s cash burn and access to capital. Now, the single biggest risk to Nio stock may be regulators, both in the U.S. and China.
Fortunately, Nio and the auto industry in general haven’t been major targets for Chinese regulators. Those Chinese regulators have been going after big Chinese tech stocks hard for antitrust violations, data collection and storage practices and other potential illegal activities.
Nio doesn’t appear to be at risk on any of those fronts at the moment. Unfortunately, the China crackdown has soured global investor sentiment toward Chinese stocks in general. Nio stock could continue to get dragged down by the selling pressure.
In addition, Nio investors have serious risks associated with U.S. regulators as well. Last year’s Holding Foreign Companies Accountable Act requires foreign companies to meet U.S. auditing standards or risk being delisted. It’s not exactly clear at this point what those standards will be. It’s also not clear whether or not China will allow its U.S.-traded companies to meet them. China was perfectly content sit back and watch while China Mobile was delisted from the New York Stock Exchange earlier this year. The same fate could await Nio stock at some point in the future.
Nio’s Valuation Is Risky
The biggest difference between gambling on Nio in April 2020 and gambling on it now is its valuation. In April 2020, Nio stock was trading at $2.82 per share. Today, its trading at $35 and has a market cap of $58 billion.
By virtually any valuation metric you use, the stock looks extremely overvalued. Its price-sales ratio is 13.3x. It has no free cash flow, and analysts aren’t projecting positive earnings until 2023. Even then, Nio stock is already trading more than 70x analyst 2023 earnings projections.
If everything works out perfectly for Nio over the next three or four years, I could see the stock doubling or tripling from its current level. Nio stock was a lottery ticket bet in April 2020. It’s now a lottery ticket with a much smaller jackpot.
On the date of publication, Wayne Duggan did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.
