Zomato’s share price rallied over four percent on Wednesday after the company reported a widening of losses, but substantial growth in revenue in its earnings for the quarter ended June 2021.
Is the euphoria around the new business stocks justified? With initial public offerings (IPOs) at high valuations hitting the markets every other day and the continued bull run in equities and indeed most asset classes, CNBC-TV18 spoke to valuation guru Aswath Damodaran who is the Professor of Finance at Stern School of Business at New York University, to answer that question.
Damodaran believes that when it comes to these companies one needs to stay away from metrics which scale to current earnings, current revenues.
"No matter what I think about Zomato or any other startup whether it is Airbnb or Ola or Uber, scaling to current metrics are always going to give you absurd numbers. Why? Because you're buying for the future. You are not buying what is there right now. You are buying on potential, you are buying on hope and there is nothing wrong with doing that. The question is, is your potential or hope within reason or you are just making up stuff? Are you doing it in a fairy tale? My concern with some of these young companies is not that you are paying for future potential, but that we are not asking the right questions about these companies before we decide how much to pay," he explained.
Damodaran teaches equity valuations as one of his courses in Stern and he had made a splash on Twitter when before Zomato's IPO, he said he would value Zomato at Rs 41.
According to Damodaran it dominates the Indian online food delivery market and the Indian online food delivery market has plenty of potential for growth.
"The growth is going to be very closely tied to two things - how quickly India grows as an economy because if you don't have disposable income, you are not ordering from a restaurant, and the second is how quickly Indian food habits change. I mean, I gave the example and my experience, they get too old to have any resonance of growing up in India well eating out was not the norm. It wasn't even the exception you just did not eat out, it was just not done. I mean, clearly, things are changing," he said.
The share price debate
The Stern University professor sees India becoming more prosperous in the future with an increasing number of Indians ordering food. Given that Zomato will be a key player, he still feels that the share price should be around Rs 40.
"Does that mean that everybody is buying Zomato at Rs 130 are crazy? Not at all. It just means that from my perspective, it doesn't make sense for me to buy. And investing has to be a personal decision. And from that perspective, that is what troubles me about Zomato is that things that need to happen to justify the price, I just don't see as plausible. So it drives my decision," he said.
Zomato promoters have spoken about a cultural change and shift. The projection as per the company is that people will start ordering six times a week.
"I think that is a reasonable assumption, whether you go from one to six or one to three is the question. And whether all three happened through Zomato, whether people are going to use Swiggy or Amazon Food is open for discussion. So even if I take that premise, it doesn't lead me to the pricing," Damodaran said.
What justifies Zomato at 130/share
The only way Zomato can be valued at Rs 130, according to Damodaran, is that if it replicates its success in the food delivery market to delivering groceries and health services.
"You have to expand the market massively to get to the pricing. So it is not a sufficient story and the fact that even the optimists are not giving a story big enough to justify Rs 130 is troubling," said Damodaran.