Investing in Growth Stocks: Balancing Qualitative and Quantitative

'I haven't come across a single household that does not use Zomato or Swiggy for ordering food and groceries. I am telling you Rahul, the growth runway for these stocks is huge.'

This was my ex-head of research sharing his opinion over a piping hot lunch of tandoori rotis and paneer butter masala.

He was ruing the fact that he did not buy Zomato for his fund when it had fallen to its all-time lows back in early 2023.

His only problem was that he didn't quite understand how to value a stock like Zomato. Nevertheless, he was confident that a 'Buy and forget for 10 years' kind of a strategy may still work quite well for the food delivery major.

After all, there's every chance that Zomato would be creating new sales records 10 years from now.

Well, whether the stock was at Rs 50 a couple of years back or more than Rs 200 like it is right now, I was very clear about my strategy right from day one.

To me, Zomato falls into the category of speculation, an intelligent speculation perhaps. I don't mind investing a portion of my corpus in the stock that I am perfectly happy losing.

As Benjamin Graham loves to point out, speculation is neither illegal nor immoral. All you have to do is ensure that you are not overdoing it and risking more money in speculation than you can afford to lose.

You see, qualitatively, Zomato ticks all the right boxes. It is a market leader, has shown great ability to scale up and enter new businesses and has plenty of growth runway ahead of it.

However, it is the quantitative that is bit of a concern. The company has reported losses in 8 out of the 10 full financial years historically and has consistently raised capital and diluted equity to fund its aggressive expansion plans.

Valuations are another big concern. At almost 13x market cap to sales, the stock is more expensive than even world class franchises like Nestle and HUL, which command a market cap to sales of around 10x.

Yes, it can be argued that Zomato is growing faster than these mature FMCG giants. However, in terms of profitability and pricing power, Zomato is far behind these behemoths currently.

You see, I regard Warren Buffett and the late Charlie Munger as one of the best qualitative investors out there. So, will these titans be tempted to buy a stock like Zomato given its qualitative strengths and its enormous growth potential?

Well, I don't think so. For Buffett and Munger, the quantitative should also complement the qualitative. The company should be profitable and highly capital efficient today and not at some future date.

Besides, they are more about buying with an adequate margin of safety and would like to come nowhere close to Zomato's expensive valuations of close to almost 13x market cap to sales.

They are happy to let go of a multibagger than compromise on their valuation standards.

Conclusion

If you are like me, who pays equal attention to both the qualitative as well as quantitative, then you may certainly want to put the stock into the category of speculation and wait for the numbers to improve dramatically from here.

However, if qualitative is what excites you more and you are fine with overlooking the company's current financial performance in exchange for a much brighter future, then the stock does deserve a place on your watchlist.

The choice is yours. Choose carefully though. There are no extra marks for attempting to answer the more difficult questions in investing.

In fact, if anything, the simpler the investment, the better your long-term results could turn out to be.

Happy Investing.

Warm regards,


Rahul Shah
Editor and Research Analyst, Profit Hunter
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)