Unfamiliar Business & Inefficient Discounting
- 6 days ago
- 5 min read
How efficient markets are in discounting a stock varies across times & situations. Sometimes & in some situations market is highly efficient in its discounting of the future whereas in some situations & sometimes it is highly inefficient.
Relatively the market is most efficient in case of stocks with stable & secular growth wherein there is hardly any room for major surprises.
So, something like an HUL with say 4-5% growth will suddenly not grow at say 10-15% and surprise market either on growth or on profitability and thus price moves in HUL will never be highly volatile except for some market driven events. In such types of situations, it is highly difficult for investors to generate any meaningful alpha given that not only the business lacks a surprise element but also the market is highly efficient in quickly discounting any change or surprise.
The other end of spectrum here is unfamiliar businesses or newer businesses. In new businesses markets are relatively inefficient in discounting given that it does not has a clear visibility & understanding on its medium-long term growth prospects including what kind of profitability the business might eventually generate.
In such cases markets in the initial few years of stock’s listing is mostly reliant on the company’s near-term performance and guidance provided by the management for its discounting; till the time the company achieves a certain scale from wherein things are more linear & clear and/or till market is able to build a decent understanding of medium-long term possibilities in the business.
In the initial years market generally under-discount the long term potential while also over-discounting short term performance resulting in very sharp moves.
For example, consider some of the newer businesses like Zomato, Policy Bazaar, Paytm, Cartrade etc which got listed few years back;
their listing valuation was determined by private investors and not markets
Once listed, markets relied on near term performance which was not what they expected. Listing pitch was that these companies will be able to generate XYZ profitability in the medium-long run, but markets due to their unfamiliarity were only looking at near terms results in which the profitability was not improving.
Thus, all these stocks saw >50% correction in just few quarters
In all these cases, in the initial year of the listing none of the managements provided any guidance on what kind of profitability the business can generate & by when they can achieve it and thus market had no clue except for near term performance (which was not improving) for its discounting.
Eventually all these businesses did saw improvement in profitability plus all the managements also provided a sense of what kind of profitability the business could generate over medium term.
As a result, market now had some understanding and thus its discounting improved resulting in these stocks becoming multi-baggers from their lows.
And now as market has built a few years of tracking of these businesses and these businesses having achieved a certain scale & profitability level; the market’s discounting of these businesses has relatively become efficient.
This is one of the primary reasons why now when in case of Zomato, there were some apprehensions about Blinkit’s profitability due to increased competitive intensity and also deterioration in Blinkit’s profitability in last few quarters; the market did not get overly worried, because it has a sense of what kind of profitability Blinkit can achieve in medium-long term and it is not just looking at near term results for its discounting.
One recent good example of what I have highlighted above is that of Zaggle;
The stock got listed ~1.5 year back
Business wise it is a B2B fintech player wherein market does not have a good understanding of its business and thus its potential
(note: my comment that market does not have a good understanding of its business is based on my interactions with multiple investors & funds and how they look at Zaggle’s business and also on how market has been discounting business’s near-term performance)
Since its listing in Sep’23 to Dec’24 the stock went up ~4x as it delivered increasingly strong near-term performance resulting in market over discounting the near-term performance.
The company was even able to do a large fund raise in Dec’24 at near high prices as market was discounting the very strong near-term performance.
However, Zaggle’s performance in last few quarters was not what market was expecting based on its previous few quarter’s performance, the business was seeing margin contraction and thus market’s discounting started working in reverse so much so that stock went down ~50% in just few months.
(I know of large funds who bought in QIP in Dec’24 and sold in subsequent months due to results not being as per expectations)
But in its recent Q4FY25 results, the business has seen some stability in margins and the management has also provided a good outlook on margins for the coming year.
As a result, the stock is now again being bid up; already up ~35% since results last week.
In essence, market does not have a good understanding of the business here and is mostly relying on near term business performance in its discounting of stock
Readers who want to understand the business of Zaggle can access our research on the same here-
The key takeaway for readers here is that such newer businesses offer some of the best alpha creating opportunities for investors as markets will be most inefficient in such businesses as it does not clearly knows the potential future. Investors who are able to develop good understanding of the business and its medium-long term potential before markets will clearly have an edge in these opportunities.
Plus, the number of such newer businesses getting listed are increasing in our markets which provides an increasing pool of opportunities to select from.
Three key factors which market gets wrong in discounting in such businesses (in the increasing order of failure) are;
Long term revenue growth potential
Eventual profitability that the business can generate
Upside from pivots & optionalities
Optionalities traditionally are one of the key areas of poor market discounting. I had covered it in a detailed post here-
Interestingly most of these newer businesses are actively pivoting & working on creating new lines of businesses; which again adds of market’s lack of ability to clearly discount the range of possibilities in these stocks.
An Idea Worth Looking at in the Current Market Correction 🔗 https://www.surgecapital.in/post/an-idea-worth-looking-at-in-the-current-market-correction
Comments