Last Friday, the shares of Delhivery, a newly listed logistics company, fell 18% on announcing that business volumes have been weak in the September quarter. Delhivery claims to be building “the operating system for commerce,” through a combination of “world-class infrastructure, logistics operations of the highest quality and cutting-edge engineering and technology capabilities.” But it does not make any money. In the June quarter, it reported a loss of Rs308 crore, which, on an annualised basis, is much higher than the FY21-22 loss of Rs864 crore. With a few hundred crore rupees in the bank and in financial investments, it will not be long before Delhivery runs out of cash and takes steps that may dilute existing shareholders' investment value.
It is the same story with another new-age food delivery business Zomato. Like Delhivery, Zomato has made no profits in its lifetime; it has been losing about Rs1,000 crore a year, though losses seem to be reducing now. Along with these two, several other tech companies, like PB Fintech (Policybazaar), CarTrade and Nykaa, have also been steadily losing value, as investors wake up to the fact that there is no chance of these companies making enough money to justify their current lofty valuations—even after they have dropped 50%-60% from the listing price.
The market regulator Securities and Exchange Board of India (SEBI) has announced tighter disclosures for such issues, which, as I discussed last fortnight, are of no practical use. In doing so, SEBI has also skirted the issue of the accountability of lead managers.
Another aspect of this picture that goes unnoticed is the investment by mutual funds (MFs) in these dubious companies. What is the application of mind in making these investments and putting investors’ money at risk?
For instance, long term advantage fund series I, II & III (which are all tax-saving schemes) holds Delhivery shares to the extent of over 3% of the portfolio. Paytm finds a pride of place in Tata Nifty India Digital ETF (2.51%), Mirae Focused Fund (1.23%) and HDFC Nifty 100 Equal Weight Index Fund.
Nykaa, which reported a semblance of profit, unlike the other tech stocks, is present in the portfolio of Tata Nifty India Digital ETF (3.38%), and Invesco India Focused 20 Equity Fund (2.56%). Policybazaar finds a place in Tata Nifty India Digital ETF (2.38%), Franklin India Opportunities Fund (1.91%) and Franklin India Technology Fund (1.90%).
I have only picked up the top-3 schemes with the largest exposure today. There are plenty of other schemes with smaller exposures and also those that entered and exited at a loss in these stocks.
SEBI assumes that arming retail investors with more disclosures would lead to better investment decisions. If that is so, how is it that mutual funds, who are armed with deep research and information and charge a fee for fund management, have invested in these loss-making stocks that are continuously sinking?
The common argument in favour of mutual funds is that a stock may sometimes look attractive at the point of investing but lead to disappointing returns. This is part of the normal investing process of hits and misses.
However, this 'process' cannot be an automatic justification for investing in any stock. There has to be more probity in investing public funds when they buy loss-making, over-valued stocks and give an exit to privileged private funds investors who made their investments at a fraction of the value.
The Buying Process
While explaining their buying process, most mutual funds focus on 'fundamentals' of the business such as expected sales and profit growth, return on investment, and free cash-flows. These are then matched with valuation parameters such as price-to-sales, price-to-book-value, price-to-earnings, and price-to-cash-flow.
It would be ideal to find a stock with improving fundamentals at a low valuation, but this happens only after a bone-crushing bear market. More often, fund managers settle for a trade-off between improving quality and moderate valuation, which has yielded expressions like growth at a reasonable price, since earnings growth is the most-favoured of fundamental factors.
Fund managers can go wrong in estimating growth and end up buying a dud. That is perfectly understandable. But if fundamental factors themselves are rotten (no profit growth or losses, negative cash-flows), how can they justify investing in such companies? No valuation is low enough in these circumstances. And, yet, such high-priced stocks have crept into the portfolios of several mutual funds.
The only reason to buy stocks with no embedded quality is speculation: buy today and hope to sell at a higher price in future—irrespective of intrinsic worth. This is a legitimate trading strategy (based on price patterns alone) but mutual funds don’t claim to be short-term traders (bhaw ke khiladi).
In short, while SEBI is focused on weighing down direct retail investors with more disclosures, mutual funds, as experts and custodians of another set of retail investors’ savings, play a speculative game they are neither supposed to nor equipped to do.
Now that these highly visible new-age, tech-based companies are listed and traded daily, we have come to accept them. So, it may seem incredible, but without a public listing, they would have died a natural death having burnt oodles of cash belonging to rich investors.
These investors got an exit when these loss-making companies were allowed to enter the market through SEBI’s generous but flawed listing regulations. But it is hard to see why mutual funds, with a mandate to be responsible with retail savers’ money, should be part of this speculative nonsense.
(This article first appeared in Business Standard newspaper)