Jio Financial: Moon Shot or Crash Landing?

May 13, 2024

Jio Financial: Moon Shot or Crash Landing?

If you look at the share price performance of Jio Financial, you will realise that the stock has done quite well in recent months. In fact, it is up an impressive 80% in the last six months.

The Reliance lineage, the huge opportunity staring the company in the face, and a few positive developments in recent months, has led to the investors showing a strong interest in the stock.

However, if you ask me, I am not that bullish on the stock just yet.

In fact, the stock is more of a speculation than a sound investment in my opinion.

Yes, that's right. I won't call the stock an investment worthy stock at the current juncture. It may be an intelligent speculation but is still a speculation in my books.

Let us know why.

One of the best definitions of what constitutes an investment, comes from none other than Ben Graham.

As per him, an investment operation is one which upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.

Here is my practical version of Graham's definition of a sound investment.

This is a historical financial snapshot of a company called as J Kumar Infraprojects Ltd.

The reason for choosing this company is that it starts with the letter 'J' like Jio Financial and nothing else.

This way, I will not be accused of cherry picking as I have some logic to my stock selection.

Anyways, the company does have decent financials except for FY21, which can be ignored because it was the year of the pandemic.

The average debt to equity ratio is well inside the danger zone and the average ROE and ROCE are also decent if not great.

Now, the final piece of the puzzle is the valuation. You see, three years ago the stock was trading at a price of around Rs 180 per share. Therefore, if you consider the average earnings power of Rs 18 per share, the stock was available at a PE of 10x.

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A PE of 10x is a very decent multiple and can be considered as attractive for a company like J Kumar Infraprojects. Thus, we were getting a fundamentally sound company at an attractive PE of 10x.

Ben Graham's criteria of safety of principal and the promise of an adequate return were being fulfilled by J Kumar Infraprojects, a company that was fundamentally sound and was available at attractive valuations. Thus, the risk-reward equation was in favour of the investors.

So, how has the stock performed since then? Well, it currently trades at a price of around Rs 640 per share, which translates into a return of 256%. In other words, the stock is close to a 4-bagger in 3 years.

Now, if you put together a portfolio of 25-30 companies that have the same fundamentals as J Kumar Infraprojects and have the same PE multiple of 10x-12x, I am quite confident that the portfolio will do well over a period of 2-3 years. In fact, I won't be surprised if it outperforms the benchmark index by a significant margin.

A combination of sound fundamentals and attractive valuation has been proven to be a market beating combination and there's no reason why it should be different in the future.

Now, let's consider another 'J' company i.e. Jet Airways.

Here's the financial snapshot of Jet Airways.

As you can see, this company does not fit the Ben Graham definition of an investment.

There is no safety of principal if you invest in this company because you have no idea of its earnings power.

The company is loss making and it has negative net worth. Therefore, there is no sense investing in the company, no matter how attractive its valuations.

You see, for the stock to be an investment, both the business quality as well as valuations need to be supportive. If the business quality is bad but the valuations are attractive, it doesn't make sense to invest in the stock.

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Likewise, if the business quality is good but if the valuations are not favorable, even then it is not an investment and could be termed as speculation.

In the case of J Kumar Infraprojects, both the business quality as well as valuations were favorable and hence, it qualified as an investment.

In the case of Jet Airways, the business quality was poor and therefore, we rejected the stock.

By the way, Jet Airways is down 50% over the last three years, thus reinforcing our point that it did not qualify as a good investment.

Now, let's move over to another company that starts with the letter 'J' i.e. Jio Financial Services Ltd.

As is evident, there is only a limited history of Jio Financial. We have only two years of EPS data and only one year of debt-to-equity ratio and one year of return on equity.

If we were to go by Benjamin Graham's definition of investment, we need data of at least 6-7 years to understand the earnings power of the company. We cannot calculate the earnings power of Jio Financial based on just 1 year data.

Secondly, the stock trades a PE multiple of a huge 143x its FY24 earnings per share, which is quite expensive in my view.

Of course, a stock like Jio Financial, which is a finance company, should be valued based on price to book value and not price to earnings. However, even on a price to book basis, the stock seems expensive, trading at a multiple of 1.6x.

For an unproven business mode like Jio Financial, I prefer a price to book multiple of 1x or lower, which was the case around 6 months back when the stock was trading at close to Rs 200 per share.

Right now though, it is trading at a substantial premium of 60% to its FY24 book value per share.

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You see, unlike our first company i.e. J Kumar Infraprojects, the company's limited history does not give me a clear idea of the profits it is capable of generating on a consistent basis. I need the profit figures of at least 6-7 years in order to understand the earnings trend and to figure out whether the fundamentals are sound or not.

Secondly, the valuations also seem to be on the higher side given that it is trading at a premium to book value.

Hence, the safety of principal and the promise of an adequate return, doesn't look all that certain given the company's extremely limited financial history and its valuations.

It cannot be termed as an investment in the strict sense of the term and can be called as an intelligent speculation at best.

I need to make a confession here. You see, we have analysed Jio Financial from the point of view of finding out whether the stock can double over the next 1-2 years without relying on some big news or big growth in profits.

But what if you come across a big news or there is a significant growth in profits over the next few years. Well, in that case, the stock can witness a good rise and can even turn into a multibagger.

Hence, the verdict is clear.

If you are investing from a 1-2 year perspective and want to minimise your downside, then the risk-reward equation at the current juncture is not in favour of investors.

However, if your investment horizon is truly long term and you believe that big developments will take place in the company that will lead to a huge growth in profits over the next 5-7 years, then there's a strong chance the stock can become a multibagger.

In conclusion, is Jio Financial a sound investment from a 1-2 year perspective where there is a solid downside protection? Perhaps no.

Is it an intelligent speculation where some big things are lined up and which when successful, can give a big fillip to profits? Maybe yes.

So, take your pick and make your decision accordingly.

Happy Investing.

Warm regards,

Rahul Shah
Editor and Research Analyst, Profit Hunter

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