Nazara Technologies: Crushed by the Gaming Ban?

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Whenever you ask someone a question, the quality of their reply reveals whether they are simply repeating a common thumb rule or speaking from a place of deep, personal analysis.

Consider this question: "Why would you not invest in Nazara Technologies, especially after its 20% fall from recent highs?"

A standard response might be: "I avoid companies with high PE ratios, and Nazara's PE of over 80 makes me uncomfortable."

A more nuanced way to frame it would be: "Nazara's current share price embeds a significant speculative component, which makes the risk-reward equation unfavourable for my style of investing."

To reiterate, a person might say the speculative premium in the current price is too high, so they prefer to stay on the sidelines. If you find the second reply more compelling, let me elaborate...

A company's share price can be thought of as having two parts: An investment component and a speculative component.

Imagine a company with an EPS of Rs 10, Rs 8, Rs 12, and Rs 13 over the last four years. If it has a long, stable track record, it's reasonable to assume its future earnings power will hover around Rs 11 per share.

Applying a reasonable PE multiple of 15 gives an intrinsic value, or investment component, of Rs 165 per share.

If the stock falls to Rs 120, it's trading at a discount to this investment value. However, if it rallies to Rs 250, the speculative component emerges.

The investment value remains at about Rs 165, but the market is paying an extra Rs 85 based on expectations of future growth.

As a value investor, I'm wary when the speculative component is large. I prefer to pay only for the investment component, ideally at a discount.

Now, let's apply this to Nazara Technologies. Its EPS for the last four years was Rs 4, Rs 6, Rs 7, and Rs 9. Its trailing twelve-month EPS is higher at Rs 14.

If we generously assume an earnings power of Rs 14 and apply a liberal PE of 25, we get an investment value of Rs 350 per share.

Most value investors would be hesitant to pay significantly more than this. In fact, they would seek a margin of safety below it.

What's Nazara's current share price?

Even after the recent drop, it is near Rs 1,200. This indicates that, based on our assumptions, a very large portion of the share price is speculative.

For the current price to be justified, the company's earnings must expand dramatically and rapidly.

If this growth fails to materialise, the market could quickly withdraw the speculative premium, which would be very damaging to the share price.

We saw a preview of this when the stock fell 20% following the government's ban on online money games.

Although management clarified the impact would be limited, the market-having paid such a high speculative premium-became jittery at the first sign of negative news.

One could argue that my assumptions are too conservative-that I've underestimated Nazara's future earnings or that a higher PE is justified.

However, I'm relying on what has proven successful in the Indian markets over the long term. Historically, assuming earnings power far beyond current levels and PE multiples significantly above 25-30 has led to the downfall of many stocks.

I see no reason to abandon these principles when evaluating a company's investment component.

Of course, you are free to adjust these assumptions and form your own judgment about the composition of a company's share price.

Happy investing.

Warm regards,


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