Should I buy Deliveroo’s rising shares today?

The Deliveroo (LSE: ROO) share price has been rising today. And after the stock’s calamitous plunge from its initial public offering price of 390p, that’s some welcome relief for shareholders.

Deliveroo shares still represent a high valuation

However, as I write, the food delivery company’s shares are changing hands for close to 261p. So there’s still a mountain to climb for the firm’s new underwater shareholders.

But the share price is only important because it sets the company’s market capitalisation and therefore its valuation. The flotation price valued Deliveroo with a market capitalisation of around £7.6bn. Today, it’s near £4.9bn. And at first glance, I’d describe both those figures as optimistic given the business is unprofitable.

The past three years trading figures look like this:

I admit to being impressed the company turned over more than a £1bn in 2020. I think that’s remarkable growth for a business that’s only been around for eight years. And I’m also encouraged that losses have not been increasing with turnover. Losing businesses often make that mistake before going bust.

Of course, what’s needed to begin to justify Deliveroo’s current valuation is more evidence of shrinking losses and eventual profits. And I’m looking forward to reading the first-quarter trading update due on Thursday 15 April. There’s a chance we could see good progress.

My guess is the stock could be moving higher today in anticipation of that announcement. One risk for those buying the shares today is the up-move could reverse on results day. That’s a phenomenon that often occurs in the stock market.

Profits could remain elusive

Nevertheless, on Thursday I’ll be looking for evidence of continuing growth in revenue and shrinking losses. Without those two factors being present there’s a big danger the stock could crash further in my view. After all, the current valuation multiple is more than four times last year’s revenue.

And according to some sources, Deliveroo has made a loss on every delivery made since it started trading. That rumour suggests to me that margins will be wafer thin for all food delivery businesses. After all, there’s surely only a small amount to be skimmed from your typical chicken tikka masala. If margins were too fat, customers might start to notice the elevated selling prices of their favourite takeaway food.

To me, the business model seems low margin and precarious. And there’s a lot of competition out there such as Uber Eats and Just Eat. However, Amazon famously expanded its revenue at pace for years without generating profits. And then it threw off massive earnings later. Maybe Deliveroo can repeat a trick similar to that. After all, the model looks highly scalable.

Amazon itself owns a stake in the Deliveroo business suggesting the retail and tech giant sees potential for the setup. And Will Shu, the founder of Deliveroo, reckons the company aims is to build “the definitive online food company” and he’s “very excited about the future ahead.” Personally, I’m a little more restrained about the company’s prospects and will watch from the sidelines for the time being. However, I could be wrong.