The recent move in prices of some popular e-commerce stocks listed in India has caught the eye of the market participants. These stocks have sharply outperformed the benchmark Nifty50, Nifty IT and even NASDAQ in the past one month. Notably, these stocks have been sharply underperforming the markets for the past one year particularly. Most of these stocks have lost about two third of value from their respective all time high stock price levels. Many investors who had bought these stocks in the 2021-2022 frenzy have seen material erosion in their investment value. It is therefore pertinent to examine, from the individual investors’ viewpoint, whether the tide is turning for these companies; to assess whether they should stay invested, buy more or consider using the latest price rally to exit their positions.
Use your own parameters
One grave mistake small investors usually make while investing in the stock of a company, is to use the valuation matrices followed by specialized investors like private equity, venture capitalists, angel investors etc. or professional investors who invest on behalf of other investors.
Specialized investors evaluate a business idea in terms of potential for wider acceptability, scalability and eventual profitability. They mostly invest in early stages of business development and are usually not concerned with conventional valuation ratios like price to earnings etc. Failure of a business idea is as routine matter for them as the death of a patient for an oncologist. In fact, in their case a 25% success rate is considered a great performance. They do not fall in love with any business and are always on lookout for an exit, regardless of profit or loss.
Professional investors are mostly concerned with the relative performance of their portfolio in relation to the benchmark indices. For example, a fund manager would be considered very successful if his fund loses 10% in a year when the benchmark index has lost 15%. There is no opportunity cost of the money assigned to them for management.
In my view, small investors should use their own parameters to evaluate the businesses they want to invest in. Losing money should not be an option in their investment strategy. They should aim to earn at least more than the risk free return they can get in bank deposits and government securities.
Individual investors can earn from their stock portfolios in three ways:
1. Dividends or any other form of regular cash flows.
It is important that the company makes sufficient profits; is able to convert these profits into cash (good working capital management) and maintains reasonable free cash flows.
2. Stock prices rise in tandem with earnings growth.
Assess if the earnings growth is sustainable (not cyclical) and healthy (good ROCE).
3. Stock prices rise due to acceptability of higher valuation benchmarks like price to earnings ratio (PE or EV/EBIDTA); price to book ratio (PB); price to earnings growth ratio (PEG) etc.
Remember, higher multiple to the benchmark valuation criteria should be supported by fundamental change in the operations and balance sheet; and not just by the broader market movement or irrational exuberance.
Assessing the latest move in ecommerce stocks
For making an investment decision, investors need to assess whether the recent move in ecommerce stocks is a broader market wide move or a response to company specific developments. In case of the latter, it needs to be evaluated whether it is sustainable in medium term or just a temporary phenomenon.
For example, post 3QFY23 result, One 97 Communication (PayTM) has seen multiple upgrades from various brokerages. Analysts seem to be excited about improvement in lending volumes, operational efficiency, prospects of substantial improvement in revenue growth in forthcoming quarters and profitability at ‘adjusted EBIDTA’ level in the current quarters. The analysts are projecting marginally positive EBIDTA in FY25; but no one is projecting positive PAT or free cash flows in the foreseeable future.
As per some recent media reports, telecom major Bharti Airtel, has proposed to merge its payment bank with the PayTM payment bank in a share swap deal; though the company has apparently denied any such proposal. PayTM had also announced a share buyback program in December. Ant group of China, one of the promoter entities, has decided to materially pare its stake in the company, offering a big revenue opportunity for brokers. It is to be evaluated whether these events have excited the analysts or they have holistically changed their outlook on the stock.
In the case of Zomato, the company has announced re-launch of its membership program (Zomato Gold), termination of services in a few cities and some other operational corrections. The analysts are not too excited about these changes and have not tweaked their estimates materially. Similar is the case with FSN E-Commerce.
Conclusion
In my view, the recent rise in ecommerce stocks
could be more in the nature of a technical or generic move that may not
necessarily be sustainable. The current valuations or the projected performance
matrix of these companies provides little comfort from the individual
investors’ viewpoint.
Besides, the regulatory environment for
ecommerce business is still at a nascent stage and could have material
implications for these businesses, similar to what we saw in the case of
telecom and private mining during the past two decades. Investors need to
factor in this risk also while deciding to invest in these businesses.
By nature, all these businesses are strong and
highly scalable. If these companies sustain for 4-5years and deliver 30-40%
revenue growth, these may become profitable and generate enough cash flows to
fit in the conventional valuation matrices, without using manipulative
terminologies like ‘Adjusted EBIDTA’, etc.
The investors will get ample opportunities to
invest in these businesses in future, once they mature and the regulatory
environment stabilizes. Till then leave it to the professional investors and
focus on already matured businesses.
