Valuing Profits

An unexpected and extraordinary development at testing company Kilpest left investors grappling with a question: How does one value an extraordinary surge in profits?

- SAMAR SRIVASTAVA

As the Covid-19 lockdowns began, and investors rushed for exits, Kilpest India’s stock held steady. It saw little erosion in value during March, and through April and May, there were more buyers than sellers on most days.

The company had stumbled upon a rare opportunity and had moved quickly to make the most of it: Its RT-PCR kits, which test for the Covid19 virus, were in high demand, and Kilpest was the only listed player that could capitalise on the opportunity. A business that had never made more than ₹10 crore in annual profit over the last decade was now on track to end the year with ₹100 crore in profit. (It has delivered ₹76 crore in the first two-quarters of this fiscal.) As investors rushed in, its market cap soared fivefold to ₹550 crore in August.

But this sudden, unexpected and extraordinary development left investors grappling with a question that has come up several times over the past decade: How does one value an extraordinary surge in profits?

Past examples—there are several, such as SAIL, Rain Industries, Graphite India, HEG, Vikas WSP— have shown that in the short term, markets almost always err in according too high a multiple to the cash that has come into a business. They start pricing in the good times continuing for longer than they do. As profits rise, investors rush in, only to be disappointed as the management misallocates capital and the profits eventually prove unsustainable.