Lately I’ve been diving into Jumia Technologies due to its growing popularity over the past month. I wrote stories about how he makes money, his most popular product, and explored his groundbreaking movement from being an ecommerce retailer to an ecommerce platform. But there’s one more important topic that I haven’t touched on so far: Does Jumia stock offer good value to investors today?
There is a growing consensus that Jumia stock is extremely undervalued. For example, Citron Research, a popular short seller, recently reversed its rating on Jumia, calling it a “generational buy” and giving it a target price of $ 100 per share. As a prospect, the stock was trading below $ 20 at the time the rating change was reported. Considering Jumia stock has continued to hit highs above $ 40 a share since then, it seems everyday investors are increasingly coming to Citron’s point of view and buying this supposedly undervalued stock.
To be sure, there are reasons to be excited about Jumia’s future. But I predict that it will take a long time for the stock to produce generational returns, and most investors just aren’t mentally prepared to wait for that to be the case.
The problem of valuing stocks by market capitalization
The value of a public company is usually measured by its market capitalization: the total value of all outstanding shares. Jumia’s market cap is $ 3.3 billion at the time of writing. And enthusiastic Jumia shareholders might say it’s a good deal given the market capitalization of other regional e-commerce giants.
A 2013 McKinsey study estimated that e-commerce in Africa could represent a $ 75 billion opportunity by 2025. Therefore, many investors compare this to Jumia’s $ 3.3 billion market cap and conclude that the stock is extremely undervalued. But comparing market caps to total addressable markets is an unorthodox way to assess stocks.
This is because monopolies are rare. For example, Amazon has emerged as the leading e-commerce player in North America, but that hasn’t stopped eBay and Walmart to carve out their own multi-billion dollar e-commerce operations. Likewise, Africa will not be a win-win market. In addition, monopolies are becoming scarce as the opportunity increases. As the African market matures, expect more players to rush to harvest.
Plus, comparing all the e-commerce giants to Jumia isn’t a head-to-head comparison. Everyone has unique facets in their business, which has an impact on their value proposition. For example, Amazon generates big profits from its cloud business. MercadoLibre generates tons of revenue thanks to fintech solutions. Jumia does not. In addition, Africa currently represents a much smaller opportunity than other geographic regions.
Valuing Jumia the old way
Jumia does not have a net profit to measure, so we cannot use the useful price / earnings ratio. Therefore, one of the only traditional valuation metrics we can use is price / sales (P / S). Generally speaking, strong sales growth justifies a high P / S ratio and vice versa.
Currently Jumia is trading at a P / S ratio of 19 which is considered high. However, the company’s revenues are declining. In the first three quarters of 2020, its revenue fell 12% year over year, hardly justifying a high P / S ratio. As a perspective, consider that the mighty Amazon is trading at just five times its sales, but its sales in the first three quarters of 2020 are up 35% from the comparable period of 2019.
If we stopped here we would conclude that Jumia was overrated, not undervalued. However, Jumia intentionally shuts down its inside sales business, which hurts overall revenue. So maybe we can give him a temporary drop in income pass.
Consider non-first party sales up nearly 19% in the third quarter, perhaps more indicative of the future outlook. But even if we give Jumia that 19% growth rate (still behind Amazon) and add the currently untapped opportunities (like the monetization of JumiaPay, its fintech service), it looks like Jumia is already generously valued at 3.3 billion. of dollars.
What market capitalization can tell us
Letting winning investments run over the years can produce extraordinary results. Thinking long term, legendary investor Charlie Munger says, “The first rule of dialing is never to interrupt unnecessarily.”
In a turbulent year in which Jumia shares have jumped nearly 500% year-to-date, now is the time to remind us that these types of annual returns are atypical. But if we patiently allow companies to build shareholder value over the years, life-changing returns can result, as long as we continue to own.
By comparing Jumia’s market cap to its addressable market, we see that it can increase shareholder returns for a very long time at its current growth rate without hitting a cap. So if the business starts to profitably grow its revenue, it is a growth stock that you can buy and hold for a long time.