New Age Stocks | Investment Strategy: How to value new-age stocks & what investment strategy to follow: Mahesh Patil

The Securities and Exchange Board of India (Sebi) recently proposed rules to tighten and seek more clarity from new-age companies on pricing its shares during IPOs. This comes at the backdrop of the recent volatility witnessed in new-age company stocks. Few companies operating in various industries viz. fintech, insurance aggregation, food delivery, e-commerce retail, used car market etc. had come out with their IPOs in 2021. Business models for such companies are unique and in contrast to asset-heavy and traditional firms. Further, all these industries are at different stages of evolution and maturity, making it difficult to measure value with the same lens.

Given that most of these companies don’t generate positive cash flows/profits, conventional methods of valuation cannot be relied upon to determine their intrinsic value. Investors need to rely on various key performance indicators (KPIs) which should be used to gauge the true potential for such companies. Among the most often used KPIs are – active users, transacting users, frequency of transaction, Gross merchandise value (GMV), Average Order Value (AOV), Contribution Margin etc.

Firstly, investors should ascertain the total addressable market (TAM) opportunity of the business based on the product/service being offered by the new age company. Such companies offer convenience, accessibility, and other quality service to consumers and with tech adoption growing steadily in India, these companies should have a huge runway for growth.

GMV is the most common metric among online businesses. It measures the total value of sales. Also, AOV tracks the average amount spent by a customer each time a purchase is made. GMV is obtained by multiplying AOV with the total number of transactions. Business models for some companies are based on commission on transactions such as those for Payments Company. For such companies Gross Transaction Value (GTV) is used instead of GMV.

Other business operating metrics that should be on investors’ radar while evaluating these companies include a number of registered users, along with annual and monthly transacting users. This metric aids in understanding the number of unique customers availing service/buying product from the company on an annual and monthly basis. Frequency of transactions should also be looked at in conjunction with this metric. This gives an overall view of customer traction that the company is seeing which in turn is key factor driving revenues.

Since these companies are trying to gain market share at a fast pace, they heavily incentivize consumers and incur huge operating losses. While this is normal, it is important to understand whether the unit economics of the business are in place, such that they are on a path to profitability.

Contribution profit/margin, which measures per unit profit, is calculated by deducting variable costs such as processing charges, promotional cashbacks and incentives, logistics and other expenses from revenues. Once the scale of business grows and with consolidation or competitive intensity reducing the contribution margins can rise materially.

The KPIs discussed above are used as inputs to forecast the financials of the companies. Further, since these new age companies have higher longevity of growth, large part of the current value is derived from the future and hence it is imperative to build a long-term growth forecast. Given the absence of EBITDA/profits, Market Cap/Sales and long-term Discounted Cash Flow (DCF) are two best methods that should be employed for valuation of such companies.

Other qualitative factors should also be looked at while investing in new age companies. Leadership in the industry of operations becomes pivotal. This is because such companies need to invest heavily on technology upgradation, advertisement spends etc. Commanding leadership in their respective space would mean that adequate cash burn has already taken place and hence puts them ahead of competitors in the industry. Investors should also look for entrepreneurship zeal and thought leadership in the management of these companies.

Some new-age companies which had stellar listings in 2021 have corrected over the last few months as the liquidity premium in the market has started to fade away. Liquidity tightening by Central Banks is expected to continue going forward and hence caution should always be maintained while investing in these companies. Understanding the business model and identifying the risks in totality becomes an important criterion.

Lastly, as the risk associated with these companies is high, investors should focus on investing in a portfolio of companies rather than choosing a particular company. The allocation can be increased basis life cycle and achievement/improvement in key financial and operating metrics of such companies.

(The author is Mahesh Patil, CIO, )