Memo 33 – Heads, I win; Tails, I don’t lose much!
The above title pretty much summarises the investor experience in stock markets over past 18 months. Markets continue to celebrate even the smallest of positive developments like revenge travel, re-opening of cinemas or the rise in valuation of start-up unicorns. Business media, Twitter & Instagram are full of positive interpretation even around the not-so-positive developments like:
• Rising inflation (is good because farmers & miners will earn more!)
• Slow recovery in unemployment (people are enjoying life & not returning to work!)
• Slowing down of Chinese economy (China’s loss is India’s gain!)
• Staggering debt levels of global central banks (why should I care when I have no debt!)
• Record IPO valuations of loss-making unicorns (but India’s getting its own FAANG brands!)
So easy has it been to make money in stock markets post Apr’20 that new investors have been flocking there in hordes. A case in point is the small town called Barpeta in Assam, which managed to open more trading accounts than Hyderabad and even Ahmedabad! Many of the newbie investors have witnessed long streak of winning trades and that has encouraged them to start their technical trading & investment advisory business on whatsapp, twitter, youtube, telegram, etc.
It’s a different matter that Barpeta folks have been lured with prospect of making 3000 to 5000 rupees every day on a capital investment of merely 50,000 and that strategies of some of these new breeds of advisors have been back-tested for only 3-5% market falls. The purpose of this article is not to worry about the investors of Barpeta or new breed of advisors or their followers. Time will ensure that everyone will learn the right lessons. The purpose is to re-access some of our actions, assumptions and expectations even as we celebrate the current phase of positivity.
Is the current phase of positivity unjustified?
A black or white answer to the above question is not only difficult but also futile for long term investors like us. The markets and economy are always a concoction of positive & negative things. Currently, the pace of vaccination, absence of 3rd wave, boom in start-up & tech sector, revival in corporate profits, record tax collection, opening-up of economy, etc can be seen as positives. On the other side, weak informal economy, unemployment at 2x of pre-covid levels, muted 2-wheeler & car sales, supply chain constraints, inflation, possibility of stagflation, etc can be seen as negatives. And each of these things are constantly evolving!
Thankfully, long term investing does not require us to have accurate views on any of the above. Investing can be as simple as buying a good business at a good price. Over the past 18 months, prices of large number of stocks have risen significantly; in many cases, prices have gone up way more than profit growth & future potential of those companies. Hence, it may be prudent to trim exposure to over-priced stocks in our portfolios. High prices can be strong enough a reason for the party to end! We have seen that happen in the Japanese real estate market in early ‘90s, the dot-com burst in ‘99, the Sensex story of 2010-13 and more recently in a stock called IRCTC.
Are there pockets of euphoria that one must stay away from?
While there is no clear definition as to what constitutes “euphoria”, there are a few common patterns observed in most bubbles – the stock or sector is seeing sudden surge in profits, most likely due to inventory gains; these high operating margins are expected to sustain in the future or; businesses are loss making today but valued based on abstract ideas like large addressable market, earnings potential of 2030; or stocks are touted as India’s Paypal/Netflix/Alibaba or even next HDFC/Titan.
Currently, we are seeing such signs in companies belonging to sectors such as specialty chemicals, pharma, green energy, building materials, tech-platform (Zomato, Paytm, Policybazzar, Nazara, Indiamart, etc) and not to forget Cryptocurrencies! Some of them may be good business models, but surely, they have run ahead of their fundamentals and need to rest.
An analysis of Paytm (weak business model, very high price)
After a failed wallet & e-commerce business, Paytm has now focused its energies towards the loss-making payments business. Paytm is still burning crores to acquire merchants as well as retail customers and ensure that people use their platform to make payments, in the hope that someday, Paytm can cross sell loan, investment and insurance products to this large customer base. Thus, for all the big buzz words like superapp, network effects, wealth-tech, insurtech, Paytm is going be an “agent” in the future that earns commissions out of selling loans, mutual funds, insurance, etc!
They claim to be the (Paypal + Alipay) of India. But in reality, Paytm is not even a shadow of these profitable giants, nor can it dream of getting there in the future. Alipay was built on success of Alibaba, the Chinese e-commerce giant while Paypal flourished due to friction in online & international payments for US e-commerce customers. Paytm lacks a strong parent like Alibaba that can give assured business and India’s payment system is very robust and “for free” due to the brilliantly designed UPI. Paytm tried the Alipay model through Paytm Mall, but that failed miserably.
Currently, there are no strong use cases for a Paytm user either. Though Paytm provides all facilities in its superapp, most of the customers don’t use them. May be because India has strong players in each of the large online segments – MakeMyTrip & IRCTC for travel, Swiggy & Amazon for delivery, I-Direct & Zerodha for stocks, HDFC Payzap for Banking, etc. It is hardly surprising that Paytm never discloses metrics as basic as “people who use Paytm more than once a month” and “people who use paytm for two or more products”, which can give us some idea on customers stickiness on the Paytm app.
Paytm with combined losses in excess of 10,000crs, is asking for valuation of Rs. 150,000crs, which is similar to that of Axis Bank which has 10,000cr of sustainable profits, lacs of crores of loans and thousands of crores of mutual funds & insurance already distributed. The media articles too talk only about funding raised from big investors and never a thing about the relevant business parameters. And the salt on the wound is that Softbank & Alibaba are going to be the largest sellers in the IPO!
An analysis of Zomato (average business model, very high price)
We couldn’t imagine life during Covid lockdowns without Swiggy & Zomato. They have become synonymous with home delivery of restaurant food. It’s true that food delivery will remain a fast-growing area for many years and enable double digit growth for Zomato. But to keep value conscious Indian hooked to its online ordering app, Zomato will have to constantly provide attractive discounts & rewards i.e. keep burning cash to keep consumers from moving to competitors.
Discounts, rewards & geographic expansion have resulted in losses of Rs. 4000crs over last three years for Zomato. Swiggy, its main rival, too has deep pockets and similar ability to keep burning cash. There are no signs that the losses may go away magically in coming future. Restaurants have a love/hate relationship with Zomato, since they have to share 15-20% of their revenue with Zomato and are yet unable to get access to customer data.
In US, we have seen large as well as local restaurants coming together and creating common app & delivery in response to high handed practices of food aggregators. More recently, Chinese government woke up to the woes of delivery staff and that has substantially increased employees’ costs for Chinese food delivery operators. It seems that growth prospects and challenges, both are equally balanced. Hence, valuing Zomato at 100,000cr today itself seems very aggressive to us.
An analysis of Nykaa (strong business model, very high price)
Nykaa seems to be doing lot of things well. They have built a credible platform which is helping expand the depth & breadth of India’s beauty market. Its ecosystem of product discovery & delivery is attracting all the important stakeholders of the beauty ecosystem on its platform – the best beauty bloggers & influencers work with them, who in turn created more content and brought more traffic, which deepened customer engagement. This in turn attracted local & global beauty brands to list their products on Nykaa, further increasing the product basket and the virtuous cycle.
Versus Zomato, Nykaa doesn’t burn billions to generate its revenue. In fact, it is among the rare breed of start-ups with an eye on profits. Large Global & small local brands like Estee Lauder, Innisfree, HUL, Minimalist etc view Nykaa as an enabler for their business and not a threat. Nykaa has truly created an ecosystem where interest of all its stakeholders is aligned. The IPO was reasonably priced but the listing price already captures few years of good execution.
Don’t buy steel at the price of gold!
Everyone is searching for the next Google or Amazon or Tesla and accordingly creating narratives around the new IPOs. Some investors claim that traditional methods won’t work for evaluating these new age companies! But we would like to stick to our understanding that sooner or later, every start-up will be evaluated on its ability to generate sustainable profits.
What should we as investors do?
The task for any investor after 18 months of rally is quite simple – ensure that your portfolio does not have large allocation towards stocks that are in the euphoria zone. There is very little euphoria in gold and sectors like banking, NBFCs, auto & ancillaries, consumer staples because they are dependent on India’s informal economy, which is still struggling.
Covid & the subsequent market rally have proved to be a financial bonanza for the rich & white collared middle class. They have now started spending money on life-style, travel, shopping, etc. The money spent will eventually reach the informal economy (drivers, maids, mall workers, tour operators, event workers etc) and ensure that the sectors that are out of flavour today, will come in flavour next year. We are cautious on the large gains made in the short amount of time but are very excited about the long-term journey of the Indian economy & the stock market.
Trivia – the charm of freebies!
Cinemas in Maharashtra opened on 22nd Oct and INOX announced free tickets for its morning show. Tired of Netflix & Zomato deliveries, I was fully determined to make the most of this opportunity. After spending 30 mins on the booking site with multiple attempts and multiple glitches, I was about to give up. Just then, it struck me that if I order some food, INOX will at least earn some revenue and will probably allow me to book tickets – and lo, it gave me the booking immediately. The cinematic experience was amazing but I had to gulp down the pop-corn & Coke during the intermission, that too early in the morning! It’s during those moments that I re-realized for the nth time that nothing is really free and chose to make it the trivia topic for this article ?
Even in the world of finance, we are surrounded with freebies – Zero brokerage, life time free DEMAT account, interest free EMI option on online shopping, free investment advice from your banker+broker or even Quora & Insta. Some apps like CRED & Upstox go even a step further and reward you for using their platform. No marks for guessing that each of these freebies has hidden agendas and indirect costs.
If you are a HDFC Bank customer, chances are high that you would have a relationship manager (RM) who would advise you for free and try to sell you mutual funds & insurance. The bank doesn’t charge you at all but earns commission from the product provider. It will surprise you to know that HDFC Bank earned more than Rs. 3,000cr last year from such commissions. There would be no one to complain if the products sold by the RM were suitable for the client. But more often than not, the bank RM is incentivised to sell you the products that have highest commissions. After few months, the RM would move on and you would be left with an inappropriate product.
If you trade through Zerodha, Angel or Upstox, you would realize how the whole ecosystem is designed to make you trade more. The more you trade, the more margin you will keep in your account. Apart from the Rs. 20 that they charge you, they also earn some money on the unutilized margin you keep in your account (there were rumours that Zerodha earned tens of crores on this unutilized margin money in 2019). In the 350-year-old history of stock markets, it has been proved multiple times that investors who trade frequently eventually tend to lose the game.
When you use the Zero EMI or Buy Now, Pay Later schemes on e-commerce portals, not only do you share unlimited personal data, you may also end up upgrading the phone or TV by 1 or 2 notches, which tantamounts to over-spending. While we have always shared our critical data with our banks, these were highly regulated entities. That’s clearly not the case with the 100s of internet companies that want our data. With that, it’s clear, there is no free lunch and you are paying for that free service one way or the other.