Zomato IPO: A True Wealth Creator or a Speculative Bet

May 3, 2021

Rahul Shah, Editor, Profit Hunter

I put any stock I come across into one of the following three buckets.

  • Average Business
  • Above Average Business
  • Extraordinary Business

For an average business, I don't want to pay a PE ratio of more than 8x-12x its normal earnings.

For an above average business, I can go a little higher and be willing to pay anywhere between 12x-18x the normal earnings.

An extraordinary business is a rare breed and is a steal if you can buy it at 18x earnings.

In fact, some extraordinary businesses are so good, they can make good money over the long term, even after paying 35x-40x their latest earnings per share.

It all boils down to the products they make.

Extraordinary businesses make products that consumers absolutely adore. They don't mind paying a premium for those products. The brands of these businesses are very strong. Think Maggi, Fevicol or Jockey.

--- Advertisement ---
This is a Powerful Mega Trend Playing Out in India

We have uncovered a powerful mega trend that is playing out in India right now.

It could potentially generate immense wealth for early movers.

Our co-head of research Tanushree Banerjee has also zeroed in on one specific stock riding this mega trend.

It's her #1 stock pick right now.

And she believes, this could be one of the top stocks to get to potential Rs 7 crore wealth over the long term.

Tanushree will reveal all the details about this mega trend and her #1 stock at her special online event on May 17.

At the event Tanushree will also show you, how to potentially accumulate Rs 7 crore in wealth over the long term.

What you learn at the event could possibly change your financial fortunes forever.

Click here for sign-up. It's free.
------------------------------

Above average businesses also make good products. However, they are not as sticky as the ones made by extraordinary businesses. Think newspapers, motorcycles or cars.

The products made by average business are 'commodity-like' in nature. Here, customers can easily switch to another product of a competitor if they can get it at a lower price. Think steel, aluminium or textiles.

This robs the average business of the pricing power that the extraordinary business or for that matter, even the above average business enjoys.

Thus, the extraordinary business make the most profits and the average business, the least.

You can think of these three businesses as three types of fixed deposits.

  • An average business is like a FD that pays 10%-12% interest per annum.
  • An above average business is a FD that earns 12%-20% per annum.
  • Last but not the least, an extraordinary business is like a FD that can pay as much as 40%-50% per annum and can continue to do so for a long time.

For perspective, something that compounds at 12%, 20%, and 40% goes up 3x, 6x, and 29x respectively over a 10 year period.

Learn: How to Potentially Accumulate Rs 7 Crore in Wealth Over the Long-term

This explains why people are willing to pay a high PE multiple for an extra ordinary business.

Where do you think Zomato fits in?

Is it an average business, an above average business or an extraordinary business?

The internet food delivery giant has filed its prospectus with SEBI and is looking to raise a whopping Rs 82.5 bn. It won't be wrong to call it the most awaited IPO of the season.

Well, the company hasn't announced the offer price yet, Thus, it may be difficult to gauge what kind of PE multiple it is asking for. Is it valuing itself as an average business or an extraordinary one?

Nevertheless, we know a few extraordinary businesses and we are also aware of Zomato's latest financials.

Thus, if the financials of the two companies match, we can conclude that Zomato has all the makings of an extraordinary business.

The extraordinary business we will consider for our comparison is Page Industries. It's the maker of the Jockey brand of innerwear. The company has been one of the biggest wealth creators on the Indian stock market over the past few years.

Here's the key financial highlights for Page Industries.

  • 9x revenue expansion over 10 years.
  • 9x profit expansion over 10 years.
  • 10 year average ROE of 49% (think of it as an FD with 49% rate of interest).
  • 10 year share price appreciation of 19x.

These are massive numbers whichever way you look at it.

--- Advertisement ---
How to Earn a Fortune in Gold, the Smart Way

Gold is on 'the verge of a decadal run' says Vijay Bhambwani, India's #1 Trader and Editor of Fast Profits Daily at Equitymaster.

He says gold has the potential to generate staggering gains in the coming years...And those who are betting on gold right now will hit the jackpot.

But wait.

While gold is an attractive investment destination, there's a very specific way to play this opportunity...

A way that ensures you rake in maximum profit and perhaps hit the jackpot...while minimizing potential pitfalls. Thankfully, Vijay - India's #1 Trader - can guide you step-by-step in the upcoming gold rush and help hit the jackpot just at the right time.

Sure, you don't want to be an average trader. That's not how you make a fortune.

Here's how you can get Vijay's guidance...
------------------------------

Now, we don't have Zomato's 10-year history. We only have its financials for the last 3 years.

And here's how they look.

  • The company's revenue has jumped almost 6x between FY18 and FY20, which is very good.
  • However, its losses have ballooned from Rs 1 bn in FY18 to a whopping Rs 23.4 bn in FY20.
  • Since it is loss making, the ROE is also negative.

To make matters worse, the company has admitted that its costs will increase over time and the losses will continue as it makes significant investments to grow business.

It's clear the company is not an extra ordinary business, at least not yet. This is because extraordinary businesses are not just profitable, they produce a lot of excess free cash flow which they pay out as dividends.

Zomato, on the other hand is a cash swallowing machine for now. It's raising a huge sum from the market through the IPO and I won't be surprised if it requires more funds in the future as well.

Thus, forget being an extraordinary business, it's still below an average business at the moment as it is not yet profitable.

Why then are investors falling head over heels for the company? Why is there such a huge anticipation for the IPO?

Well, simply because a lot of these investors expect the company to turn into an extraordinary business in the future.

They believe the company is sucking in a lot of cash alright but it will start making huge profits few years from now.

I, for one, refuse to believe this story.

I'm more from the conservative school of thought where I want my investment to be profitable from day one.

If a company has nothing to show for its efforts except for the promise that one day it will turn hugely profitable, I'm most likely to give that company a pass.

You see, most of the extraordinary businesses you see in India today, have been extraordinary for decades.

They showed years of handsome profits and wonderful returns on capital before they entered the 'extraordinary' hall of fame.

To say that Zomato should gain an entry into this exclusive club on the basis of just three years of loss-making performance, is taking it too far in my view.

I would rather wait for the company to turn profitable before investing my hard earned money in its IPO.

Of course, it's a different matter if you are investing in the company purely for listing gains. Given the buzz around it, listing gains is a strong possibility.

However, I'm highly sceptical of investing in it from a long term perspective.

At least not until it turns profitable and shows signs of remaining so for the distant future.

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

Recent Articles

Are the Stock Markets Deaf to Covid Agony? May 6, 2021
Why are markets discounting the economic impact of Covid?
Why Warren Buffett Recommends Index Investing Over Berkshire Hathaway May 5, 2021
How to approach wealth generation and management in the time of meme stocks.
My Latest Recommendation Has the Perks of Being Buffett's Favourite and an Electric Vehicle Opportunity May 4, 2021
Which company from the EV ecosystem should you bet on?
The Next Smallcap Winners April 30, 2021
Price is the only due diligence one might require to buy this business.

Equitymaster requests your view! Post a comment on "Zomato IPO: A True Wealth Creator or a Speculative Bet". Click here!