Planning to invest in new-age stocks? Here's how to pick the best

About a few years back, I've written if there's a need to change the metrics in the way we value the companies. As business models are getting a radical and the astronomical pace of expansion of their goods or services leading to quicker gains in their market share, we're witnessing a rapid change in the way we deal with these companies. We probably need a different perspective if not a completely different set of parameters to comprehend and evaluate them. The recent IPOs (Initial Public Offerings) by some of the 'new-age' companies has created not just huge buzz but attracted loads of investors wanting to participate in their journeys.

So, should one jump on this bandwagon and ride the course, albeit a rough one? What one needs to, however, question is not whether one must participate or not, but does one have the appetite to hold on to the vagaries of these businesses. This is because the way accounting is changed due to the lack of cashflows or profitability in the immediate term, it turns difficult to apply the traditional metrics of valuation. Conventionally, we've seen or experienced businesses going organic and pile up big over a period. In the process they may gobble up another smaller company in the related or unrelated one to make an inorganic growth.

Projections are done based on the possible synergies and improved productivity to the original business. We would then evaluate this acquisition based on their funding to acquire – debt or equity. Also, how the funding is done, either through internal or external and in what form. The success of this acquisition depends upon how the amalgamated business integrates and synergizes to become more profitable. This would be checked on how the cashflows are generated and how the capital is allocated to grow the business. With the continued controlled monetary policy regime for over a decade, the traditional connect was lost as there was no dearth of capital and the cost of capital never being so cheap.

Another important aspect to consider in these new business models is to find out how the revenues are generated and what's the cost of operations. Most of these businesses have a 'burn rate', a rate at which external capital is employed to run the business i.e., funding just to run the show. Just that one has embraced technology doesn't qualify of creating a new business altogether. True, the technological changes or adoption have given a great fillip in the way these companies operate and expand but look beyond the jargon of network effects, sticky revenues, etc. to assess the business.

One should also give importance to the customer acquisition costs (CAC) these businesses have. What if the easy money is not available, which could be the case in the medium term from now. How would a business survive, if not prosper, that's the question to be asked before considering your penny is shared. There could be a few genuine companies creating a new category or niche through their businesses but profitability is the first reason for beginning any business. One must always look for those aspects that make a company profitable or when would they possibly be. If one were finding it difficult to get an answer to this, then one could rework their assumptions and realize if this opportunity fits in their portfolio or not. Whenever these new companies are compared, names fly about some of the leaders or pioneers in these fields. Those who've successfully built and transformed their companies and the way businesses are run, altogether. It's important not to fall into the narrative but grasp if the current leadership of the company can deliver their own narrative. Most of the new-age companies that were built during the last decade have one remarkable common thread, the impeccable leadership and the executional capability of the top-management. We could easily observe that they have displayed consistent and disciplined approach to capital management while employing all the great deals that the technology has to offer. We shouldn't draw parallels but this fundamental parameter always remains irrespective of the business is anachronous.

After all our investment decisions reflect our behaviour or relationship with our money. So, the emotional connect we exhibit while making these decisions like, being cool associating with a particular company or making dashing bets on them could ignite a bit of adrenalin but it wouldn't always make investment sense. It's not always easy to rein these emotions but only disconnecting them would help to stay rational amid all the chaos. These pointers could possibly help one to identify the right businesses, not just those that succeed, but those that fit into their portfolios in tandem with the investors' risk appetite.

(The author is a co-founder of 'Wealocity', a wealth management firm and can be reached at knk@wealocity.com)