A sucker's rally needs suckers

Sucker's rally. It's not a phrase that is often used in Indian investing circles, but the phenomenon is common enough. The meaning should also be obvious but let's define it to be sure. A sucker's rally is a short-lived and unjustified increase in the value of a stock or the entire market. This brief uptick often lures uninformed investors. These investors are the 'suckers,' who will face losses when the brief illusion ends.

In recent months there has been this bubbling of hope around the world that digital businesses that earlier looked to be perennial loss-makers may be able to profit at some point. Mostly, this hope has been triggered by the buildup of the first quarterly profit that Uber has turned in. This, along with an apparent improvement in the basic numbers of some digital businesses, has led to a rally in some of these stocks.

It's a curious situation that the supposedly improving prospects of a cab-hailing service worldwide can make people hopeful that the stock of a payment company or a food delivery business might be a good buy. Still, these are the kind of hopes that large parts of the markets now run on.

Of course, 'digital' businesses should not be a category by itself because practically every business is digital nowadays. So what is this category? What's common among these businesses? For an investment analyst like me, the most remarkable thing is the paucity of profits. Profits are central to a business; without profits, there is no survival. I've been analysing stocks since 1991, and I find it unbelievable that in 2023 I have to say this. For as long as people have done any kind of business and invested in them, we have all known very well that profits are a must for survival, and the sooner a business becomes profitable, the better it is. What's more, the ratio of capital a business has employed and how much profit it makes is also important. In this context, it's interesting that Uber has used up USD 25 billion to turn in its first quarterly profit.

For some years now, the belief in the supremacy of profits has become a marginal view. Many people, especially in the media and social media noise, had started thinking that profits were optional and what was important were ridiculous metrics like being a unicorn. For a while, these ideas also infected the real world By the real world, I mean the equity markets. However, the wave of digital IPOs of companies like Paytm, Zomato and others like them has left the markets littered with profitless zombie stocks and brought a certain amount of reality back into investors' attitudes. Until just a few years ago, a business that was making losses, especially large losses, would quickly have to find a way to profitability or shut down. They would have no way to continue operating. Those days when profit-making companies grew their businesses and loss-makers shut down seemed to be over for a while, but maybe not.

A business needs money to survive. That can come from revenues, or it can come from investors. It's quite clear that what has changed now is that the free flow of zero-cost dollars has been shut off from the US economy. As should be obvious to anyone observing such businesses, this tightening of the money flow is the best thing that could happen to these digital businesses and us investors. The prospect of tight money has made all these companies focus on profitability. Those who manage to make money will come out stronger, and those who cannot will die. This is precisely what happened in 2002. The Amazons and the Googles survived and flourished while those like Pets.com, Webvan, and Boo died out.

We're likely seeing the same story play out again, and it's good for all of us. It's crucial for investors, including ourselves, to remain centred on the traditional, proven methods of investment grounded in sound fundamentals. Profits appear to be back, but in fact, they had never actually gone out of fashion.