“Yeah chal kya raha hai” (what is going on)

“Sab fraud hai” (everything is fraud)

“Crazy times”

“Investors into these will learn some hard lessons”

Statements like above are part of every discussion nowadays. It is especially after the bumper listings of Zomato followed by Nykaa and PB Fintech (Policybazaar).

Many other similar new age businesses including Paytm and Ola are due to get listed soon.

Some common features of all these businesses –

• They are heavily private equity funded.
• They are technology driven and trying to address core needs of the Indian consumer.
• They have spent significant money to reach the current levels.
• They have been reporting good top-line growth but are either loss making or reporting negligible profits.
• Their path to future profitability is unknown.

Result – their traditional valuation numbers including price/earnings (P/E) and price/ book (P/B) look astronomical when compared with any traditional established business… and hence the above statements.

Let me accept here that I am equally to be blamed for making the similar statements.

Infact, the idea of the current post came from self analysis and is more of a note to myself than any gyaan to anyone else.

Following are the key considerations:

Traditional businesses provide an established track record and hence a more predictable future. Longer is the track, the more predictable they become.

Start-ups reflect limited track record, a large addressable market, run by nimble young managements, controlled by large experienced investors and hence an exciting but uncertain future.

Difference between the two situations therefore result in different ‘probabilities’ of how the future can unfold for the two categories and hence the growth rates.

• An established business, say Nestle has a very high probability of continuing to remain Nestle even after 10 years and hence a more predictable but moderate expected performance; whereas
• A new business like Zomato, that is ready to accept new challenges has a better probability of striking windfall from existing (but emerging) business or some new business (like Amazon with AWS).

… especially as they make profits and have large money at their disposal.

This is a question I have wondered over the years and have come to the following conclusion.

Theoretically they can, practically it’s rare.

Reasons –

• Slow decision making;
• Operating in a comfort zone;
• Threat to the core business;
• Compulsions of public markets, if they are listed. How many of us would be comfortable of HLL trying to create an ecommerce platform and burning significant funds every year with no visibility about the profits;
• Hesitancy to dilute and loose control by raising private money

Can Asian Paints invest 2 billion dollars on building something and keep writing losses?

Whether they have money – Yes. Whether they would invest – Unlikely.

The moment they report losses in the new business, investors will get jittery about their core business, start questioning and that will start reflecting on their stock price.

You may argue, why then their wealthy promoters (instead of Companies) can not do it?

Again theoretically yes, practically it’s rare.

Most promoters use existing businesses to fund new ventures and not their personal wealth. Besides, most of their wealth is tied up in the core business shares and to liquidate/ pledge those has it’s own implications for the underlying stock.

I know some of it is changing and some corporate groups e.g., Tata, Reliance are venturing into this field.

However, I personally don’t expect this to become a wide trend.

I am more keen and bullish on traditional businesses and new businesses working together to leverage on each other’s strengths. E.g., the recent tie-up between HDFC Bank and Paytm.

We arrive on our conclusions based on whatever information is available. However, the fact remains that unlike the established businesses, we are not much aware about the plans of the startups.

Take a recent example where Zomato suddenly became aggressive on the startup investing.

This is not to endorse Zomato’s strategy. However, the fact remains that these entities are very open towards experimenting and can drastically extend/ change their business strategy.

Guaranteed, many of those will fall flat. However, some may work and do wonders to the overall proposition. Last man standing, consolidation are the tricks of this segment and that’s the way they are used to make it work.

As they say, if you survive long enough, opportunities arise and times change.

Look at Tesla. It had approached Apple around three years back and it didn’t even get the meeting. Since then Tesla has become one of the best wealth generators.

Under the circumstances, it’s next to impossible to take future calls on startup business models based on publicly available information .

Best that can be done is to accept that “We are not know all types”.

There must be a reason why Nykaa’s IPO was heavily over subscribed and Paytm’s not. Much more detailed discussions on future plans happen during road shows with institutional investors than during media interviews for retail.

That doesn’t mean that I am advocating to invest because of FOMO (fear of missing out).

What I am only suggesting is being humble and a continuous effort to look for the unknown.

If we can find the answers, well and good. If not, no one is forcing us to invest.

If you agree with the above three considerations, it’s easier to conclude the following –

Valuations

• for established business – possible with a greater certainty
• for startups – impossible

Analysts recommendations and target prices

• for established business – makes some sense
• for startups – makes no sense

Key theme remains the same for the above conclusion – with how much certainty someone can predict the future. Even start-up founders themselves would not know how the business would unfold over the next 2-3 years but there are analysts models predicting decades ahead and based on those the recommendations and the target prices.

Though analysts should not be blamed here – they are doing their job. They are not forcing you to buy.

• Whether it should be an established business?
• Or start-ups?
• Or a mix of two? and if yes in what proportions?

Only you can answer this question for yourself based on your own skillset and risk aptitude. You have to consider these two as totally different asset classes, though both are classified under equity investments.

There is Warren Buffett, who is a legend but never invested in new age businesses and then there are many hugely successful private equity funds who have made all their wealth from those businesses.

Listing of the likes of Zomato, Nykaa allows you to invest into businesses that were not available to public before and it’s not that they have come to you at the top of the cycle and there is no growth runway ahead. How would it all play out is anybody’s guess.

Granted – during corrections, these would be some of the hardest hit stocks and can see significant drawdowns. But that’s the nature of these stocks. Some of them will die down and some will end up bouncing much faster and stronger. Dot com bust resulted in significant drawdowns in every tech Company – many died down but some also survived and thrived including Amazon.

If you don’t have the similar risk aptitude – ignore that they even exist.

One will have a relatively more linear curve investing into established businesses compared with start-ups where one is bound to do some trekking over the mountains.

I hope the above made sense to you and helps you somewhat in improvising your own investing strategy.

Being more of a traditional value based investor, I myself continue to be amazed and confused about the sky rocket valuations that start-ups are commanding in today’s market.

However, given that how the world is evolving, rather being rejective, I have started questioning myself as to whether I am missing something.

So far, I have not got the courage to invest in these stories. In future whether I will – I still don’t know !

Another article on the subject that was recently written by Nithin Kamath of Zerodha – Investing in high growth, low profit businesses?

Other  inves4 articles that you may find interesting –

• What management wants me to know VS what I actually want to know !
• 3 key learnings from inves4’s journey so far