If I ask you to name three stocks that come to mind when I say ‘new-age tech stocks', chances are good that we would be talking about the three stocks mentioned in the title.
In fact, these stocks have become synonymous with fast growth and IPOs at sky high valuations.
Investors didn't really care about profits of these firms. As long as the story was hot, they were confident of making profits on their investments. Besides, one of these firms, Nykaa, was already profitable at the time of its IPO.
All three firms had great long-term growth stories…and investors loved them. All three had solid listings when they hit the primary market with their IPOs.
It seemed nothing could go wrong.
But then it did.
As I write this FSN Ecommerce (Nykaa) is down 77% from its listing price, despite a massive 5:1 bonus issue to stem the decline.
Zomato is down a little over 50% from its listing price.
And Paytm is down about 65% from its listing price.
By the way, their fall from the top is even worse. Here's a table of the returns of these tech stocks from the time they hit the market.
The wealth destruction in these stocks has been massive. Most investors, who didn't sell, are sitting on huge losses.
So all this begs a couple of obvious questions…
Are these stocks a ‘buy' or an ‘avoid' for those who don't have them in their portfolios?
Are these stocks a ‘sell' or a ‘hold' for those who have them in their portfolios?
These are very difficult questions to answer.
But in this editorial, we will consider Zomato, Paytm, and Nykaa, and look at the current situation of these stocks. Then you, the reader, can take a call.
Despite the massive crash, there are still people who are bullish on the stock. Recently, it bounced about 50% from its all-time low.
But clearly, the trend is still down…unless a significant amount of buying comes in to prop up the stock and prevent it from falling below its all-time low.
Our view on Zomato was summed up nicely by analyst Aditya Vora…
To start with, everything about these new age tech IPOs when it came to valuations was wrong.
How can Zomato, a loss-making company that burns cash every year, have a market capitalisation of Rs 1.4 tn at its peak? At the same time, Jubilant foods which sells Dominos Pizzas, generating massive profits, was trading at half the valuation of Zomato.
I am sure you must have come across people talking about Zomato at the price of a Tomato. What a colossal fall it had from a high of Rs 160 to a low of Rs 42.
We can debate about Zomato and whether it is a good investment or not. But the point I am trying to make is that such stocks must be viewed in relation to its peers in India and abroad.
At Rs 1.3 tn marketcap, not buying Zomato was a no brainer. But at Rs 0.3 tn can it make sense to play the Indian food delivery market?
Well, in the stock market, everything is good at a price. The only thing we need to figure out is what that price is.
Aditya also did a video on the stock – Time to Buy Zomato?
Now the fundamentals of the company have been improving. It's not all bad for the stock.
So here's what we can say about Zomato…
If you don't have the stock in your portfolio, you will need to decide if the fall in the stock is sufficient to take a long-term call. In other words, does it offer sufficient margin of safety or not?
You will also have to be comfortable with the idea that the stock could fall further. After all, it's still a loss-marking company. So in the case of a decline in the overall market, this stock could fall below its all-time low. Are you comfortable with that?
Now if you are holding the stock, then your action will depend on your purchase price.
Are you sitting on a huge paper loss? If so, consider prospect that along with improving fundamentals of the company, the stock could go up over time. That would cut your loss but it will take time.
If your loss is minor or if you are in the green, having bought it near the recent low, then your action would depend on the reason you bought the stock. Was it to speculate on the price? Or was it a long term investment?
If you bought it for speculation, then you will need to have a clear exit price in mind.
If you have recently bought it as a long term investment, then you will need to closely track the improving fundamentals of the company and also regularly assess the story. Is it playing out to your satisfaction?
Now that we have covered the various potential buy, avoid, hold, and sell scenarios for Zomato, let's consider Paytm and Nykaa too.
Before LIC there was Paytm.
It was India's biggest IPO when it hit the market in November 2021. The hype was massive. The stock market sentiment was strongly positive back then.
The Rs 183 billion (Rs 18,300 crore) IPO received bids for over 91.4 m shares against the total issue size of nearly 48.4 m shares. The retail category was subscribed 1.66 times.
The journey since has not been pleasant as the stock has been on a one-way decline.
We've seen just how damaging the selling can be once the post-listing, lock-in period ends for pre-IPO investors. The stock has been hit by large block deals involving these pre-IPO investors.
There doesn't seem to be any respite as the company is still far away from stopping its cash burn or turning nominally profitable.
So what do we do in this case?
Well, the situation is a little different compared to Zomato.
Apart from its size and brand name, Paytm doesn't seem to have any serious competitive advantage (i.e. moat) to speak of. In its payments business for example, there is no impediment for a user to switch from using Paytm to Google Pay…or any other service.
Thus, if you don't have the stock in your portfolio, then it makes sense to track the fundamentals closely and invest only after you are sufficiently convinced the company is not only on the path to profitable growth and positive cash flow, but also has a strong, long term competitive advantage.
On the other hand, if you are holding the stock, the situation is similar to that of Zomato. What was the reason you bought the stock in the first place? The answer will decide your next course of action in the stock.
Now this is a profitable company…and this one fact separates it from the others.
It can be valued by traditional metrics like PE and PB. We don't need to worry about cash burn as the company has mostly overcome this challenge.
Also, it does seem to have a competitive advantage (i.e. moat). It's brand is synonymous with women's beauty, wellness, and fashion.
Also, the sheer scale of products it offers, across many price points, has made it a compelling, and highly convenient, online marketplace for women. It's premium retail store strategy also seems to be moving in the right direction.
This is a company that does have a viable brand that its customers keep coming back to. This should provide it with at least some pricing power in the long term.
Unfortunately, none of this matters right now due to the stock's valuations. It's PE of nearly 200 offers zero margin of safety. This is a stock in which the PB of 50 would be preferable if it was the PE. That's how expensive it is.
Now that doesn't mean the stock can't go up…but if it does, then the PE will increase even further.
Equitymaster's co-head of research, Tanushree Banerjee, did a video on the stock – Is Nykaa a Falling Knife?
So what is to be done with Nykaa?
If you don't have the stock in your portfolio, you need to seriously ask yourself if you're comfortable buying without a margin of safety. This is the kind of stock that can fall even if the fundamentals improve just because its valuations are too high.
Ask yourself what the highest PE is that you are willing to pay for this stock and how much the stock needs to fall for the PE will get to that level.
If you have the stock in your portfolio, we believe you will need to take a good, hard re-look at the reasons why you bought it.
We understand that selling at a loss is painful…but you will have to take a call on holding without a margin of safety. In that case, you are essentially hoping for a massive rise in the company's net profit which would justify the high PE.
Please note, this editorial does not provide any recommendation, i.e. buy, avoid, hold, or sell, view, on any of these stocks.
The idea was to shed light on how investors need to think when faced with a scenario of taking action on a stock that has fallen a lot.
We hope this editorial has provided some insight into the thought process needed to buy, avoid, hold, or sell these three stocks.
By the way, Equitymaster's ace chartist, Brijesh Bhatia, did a video on these three stocks based on technical analysis.
You can watch Brijesh's video here.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com