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One stock picking method is to select sectors you understand well. For individuals, consumer sectors are easiest to understand because they consume them. This, bubbly markets and hype around e-commerce startups may be why the retail portion of Zomato’s initial public offer is fully subscribed on the first day itself. The interest among institutional investors to bid for the anchor portion may also have helped. If you are wondering whether you should cast your bid, our research team has put together an insightful note that can help.
That the Zomato issue is going to be a success is a given. There will be questions still. Will it list with a pop, will those gains sustain and like DMart, will it defy conventional valuation models to go from strength to strength in market capitalisation? In some time, the question of whether the issue left anything on the table for investors or was it fully priced will be answered. But its success will have other consequences.
The high investor interest in Zomato’s issue may have prompted a number of startups — used to raising funds in the private market — lining up to float IPOs. Traditionally, startups have been sceptical about going public, with fears such as the high cost of compliance, quarterly reporting and interacting with the investment community, being in the public glare and so on.
But the biggest fear has been that public market investors won’t understand the business models and ratios that startups use, who burn cash for years -- more the better, do multiple fund raisings. Dilution is a dirty word in public markets, which are used to measuring boring metrics such as sales, expenses and profit. Profit to a startup resembles how settling in life is to a youngster.
But public market investors are not really new to such things. Just like private investors wait for the next jump in valuation to see their paper wealth grow, or even a profitable exit, public investors are wired similarly. As long as the market capitalisation pathway goes upwards, they will be up for the journey. And while they may have questions every quarter, they do take a longer-term view and not all of them sell at the first sign of trouble.
Public market investors are also accustomed to varied metrics. Price to earnings can switch to enterprise value to Ebitda when the former becomes too hot, or price to sales if profitability is missing. And sector-specific metrics are also accepted, such as the average length of stay in a hospital (ALOS) — the lower the better. Therefore, they will be willing to look at metrics that startups claim represent their business more accurately. Zomato’s offer document talks about unit economics (how much money it makes or loses on every order and why) and GOV (gross order value) and monthly active users (MAU) and what not. They will keep track of these, too.
But in the end, investor wealth will grow when Zomato’s business growth is commensurate with the cash being burnt to attain that growth. Over time, they will look for factors like retention of customers, increase in billing of existing customers, incremental money being spent to acquire new customers and whether the target market can support continued growth. Then there is that bigger question, while there is one big competitor to worry about now—Swiggy—what if a few more jump into the market.
As long as the performance and management commentary match and promises are not broken and trust is built, then startups going public will be feted by investors, and their market capitalisation will soar. But if investors spot holes in the investment argument or even the financial statements, then they will quickly cast you aside. Worse, if investor frenzy for the startup theme leads to unworthy businesses getting sky high valuations, that’s also a recipe for disaster. You just have to look at the graveyard of stocks that were market favourites in a bygone era to know that.
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