Reliance Power: 50x Surge. But What Next? 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

There are stocks where I feel sorry that I didn't recommend to my subscribers and then there are stocks, which even if they turn into multi-baggers, I am ok missing out on them as they were anyways outside my circle of competence.

Where does Reliance Power fit in? Was it within my circle of competence or well outside it when I saw its price collapse to low single digits back in 2020?

Well, it doesn't matter to be honest. What matters is its crazy rise since then. The stock which had fallen to close to Rs 1.2 per share is now trading at a princely Rs 61 per share. That's a gain of more than 50x or a 50-bagger if you will.

As I said, the stock crashed close to Rs 1 per share back in 2020. Now, let us go back a couple of years more to the year 2018, January 2018 to be precise.

What was the price back then? Back in January 2018 the stock price was exactly the same as its current price.

Yes, that's right. Reliance Power's stock price was Rs 60 per share back in January 2018.

From there, it crashed to almost Rs 1 per share over the next two and a half years. A wealth destruction of the magnitude of 98%. Almost all its market value wiped off in 2 years flat.

But why did the stock fall much? Why did it go down all the way to nearly zero?

You see, our approach to investing is not always rational. We often become emotional when it comes to analysing stocks.

If we are positive about a stock, even a small positive development leads to a disproportionate rise in the stock price.

For e.g., even a small positive development in defense sector can send the prices of defense stocks soaring these days.

Likewise for negative news. If the market is negative about a stock, a small negative development can lead to a disproportionate fall in the stock price.

Something similar happened to Reliance Power in 2019 and 2020. It recorded huge losses in two consecutive years.

In FY19 and FY20, Reliance Power incurred a loss of more than Rs 7,000 crores. For a company whose net profits was close to Rs 1,000 crores on an average, a loss of Rs 7,000 crores combined is huge.

And it is primarily these losses that triggered the enormous wealth destruction in Reliance Power. This was the emotional investor who got so scared with the losses that he exited the counter lock, stock and barrel.

If you look at it rationally though, this looked like an overreaction to bad news.

It wasn't as if the company's net worth was completely eroded due to the twin losses in FY19 and FY20.

Before the losses, Reliance Power's book value was close to Rs 70 per share. And after those two losses, it came down to around Rs 40 per share.

Hence, if you value a power stock at a price to book value of 1x, Reliance Power's price should have come down to around Rs 35 or Rs 40 per share. However, it came down to just Rs 1 per share.

A stock with a book value of Rs 40 per share, was trading at just Rs 1.2 per share back in 2020.

Please note that not everything was terrible about the company back then. Interestingly, the company was still generating positive cash flow from operations and was steadily paying down its debt.

Therefore, operationally, it was very much alive and kicking and making good cash flows.

As market conditions improved and as investors realised that things don't look all that bad for the company after all, the stock price steadily started climbing up.

Although the company still reported losses in FY22, FY23 and FY24, their magnitude was far less than before. Besides, the cash flows continued to remain strong, and the overall debt continued to go down.

Then came FY25 where the company reported a one-time income of Rs 4,000 crores and this improved the company's book value substantially and bought its overall debt further down.

Book value per share, which had further gone down from Rs 40 per share to Rs 30 per share has now climbed back to Rs 40 per share thanks to the one-time profit in FY25.

Of course, I am saying everything with the benefit of hindsight, but Mr Market gave plenty of opportunities to investors who were willing to put their thinking cap on and take a calculated bet on the stock. At Rs 1 or Rs 2 per share, the risk-reward was hugely in favour of the investor.

However, with the price now significantly higher than the book value, I am not sure the same risk-reward equation exists. In fact, its valuations now are pretty similar to a PSU behemoth like NTPC or a private sector player like CESC.

Of course, the valuations are still lower than what a Tata Power or an Adani Power. Commands. But is it in the same league as these private sector players? Is it completely out of the woods? Will it continue down the path of financial prudence?

Answers to these questions are difficult to be honest. At Rs 1 or Rs 2 per share, it was all about whether the company would survive? Figuring out the upside wasn't as complex as it is right now. To be honest, I prefer stocks where I don't have to answer difficult questions to make my returns.

And Reliance Power is indeed posing some tough questions when it comes to the expected upside from the current levels.

For this reason alone, the stock lies well outside my circle of competence.

What about you? Does it lie within your circle of competence? Do let me know.

This is all from me today. I will see you in the next session. Good bye and happy investing.