Is the tide turning for e-commerce stocks?

The recent rise in ecommerce stocks could be more in the nature of a technical or generic move that may not necessarily be sustainable. (Representative Image)

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 specialised investors like private equity, venture capitalists, angel investors, etc. or professional investors who invest on behalf of other investors. Specialised investors evaluate a business idea in terms of potential for wider acceptability, scalability and eventual profitability. They mostly invest in the 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 a matter for them, as the death of a patient for an oncologist. In fact, in their case, a 25 percent success rate is considered a great performance. They do not fall in love with any business and are always on the 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 percent in a year when the benchmark index has lost 15 percent. 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 price rise due to the 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.

Assessing The Latest Move In E-commerce 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 the improvement in lending volumes, operational efficiency, prospects of substantial improvement in revenue growth in forthcoming quarters and profitability at the ‘adjusted EBIDTA’ level in the current quarter. 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 programme 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 the re-launch of its membership programme (Zomato Gold), the 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 provide little comfort from the individual investors’ viewpoint.

Besides, the regulatory environment for ecommerce businesses 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 4-5 years and deliver 30-40 percent 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. Investors will get ample opportunities to invest in these businesses in future, once they mature and the regulatory environment stabilises. Till then leave it to the professional investors and focus on already matured businesses.

Vijay Kumar Gaba is Director, Equal India Foundation. Views are personal, and do not represent the stand of this publication.