Lately, I've been diving into Jumia Technologies due to its rising popularity over the past month. I've written stories about how it makes money, its most popular product, and I explored its game-changing move of pivoting from being an e-commerce retailer to an e-commerce platform. But there's still an important subject I've left untouched until now: Does Jumia stock provide good value for investors today?

There's a rising consensus that Jumia stock is extremely undervalued. For example, popular short-seller Citron Research recently flipped its rating on Jumia, calling it a "generational buy" and giving it a $100 per share target price. For perspective, the stock traded under $20 at the time the rating change was reported. Considering Jumia stock has gone on to reach highs above $40 per share since then, it seems everyday investors are increasingly arriving at Citron's viewpoint and buying up this supposedly undervalued stock.

To be sure, there are reasons to be excited about Jumia's future. But I predict it will take a long time for the stock to produce generational returns, and most investors simply aren't mentally prepared to wait till it does.

A bag with a money symbol is weighed against an hourglass on a scale.

Image source: Getty Images.

The problem with valuing stocks by market capitalization

A public company's worth is typically measured with its market capitalization: the total value of all outstanding shares. Jumia's market cap is $3.3 billion as of this writing. And enthusiastic Jumia shareholders might say that's a bargain considering the market caps of other regional e-commerce giants.

Company Market cap
Jumia Technologies (NYSE:JMIA)
$3 billion
MercadoLibre (NASDAQ:MELI)
$83 billion
Sea Limited (NYSE:SE) $92 billion  
Alibaba (NYSE:BABA)
$687 billion
Amazon (NASDAQ:AMZN)
$1.6 trillion

A 2013 McKinsey study estimated e-commerce in Africa could be a $75 billion opportunity by 2025. Therefore, many investors compare this to Jumia's $3.3 billion market cap and conclude the stock is extremely undervalued. But comparing market caps to total addressable markets is an unorthodox way to value stocks.

That's because monopolies are rare. For example, Amazon became the dominant e-commerce player in North America, but that didn't prevent eBay and Walmart from carving out multibillion-dollar e-commerce operations of their own. Likewise, Africa won't be a winner-take-all market. Moreover, monopolies get rarer the bigger the opportunity becomes. As the African market ripens, expect more players to swoop in for the harvest. 

Furthermore, comparing every e-commerce giant to Jumia isn't an apples-to-apples comparison. Each possesses unique facets to their businesses, impacting their value proposition. For example, Amazon generates big profits from its cloud business. MercadoLibre generates tons of revenue from fintech solutions. Jumia doesn't. Furthermore, Africa is currently a much smaller opportunity than other geographic regions.

Four quadrants reflect the relationship between price and value, with a bullseye drawn in the low-price/high-value quadrant.

Image source: Getty Images.

Valuing Jumia the good old-fashioned way

Jumia doesn't have net earnings to measure, so we can't use the useful price-to-earnings ratio. Therefore, one of the only traditional valuation metrics we can use is the price-to-sales (P/S) ratio. Generally speaking, high sales growth warrants a high P/S ratio and vice versa.

Presently, Jumia trades at a P/S ratio of 19, which is considered high. However, the company's revenue is falling. Through the first three quarters of 2020, its revenue has dropped 12% year over year, hardly warranting a high P/S ratio. For perspective, consider that mighty Amazon trades at a mere five times sales, yet its sales through the first three quarters of 2020 are up 35% from the comparable period of 2019. 

If we stopped here, we'd conclude Jumia was overvalued, not undervalued. However, Jumia is intentionally shifting its business away from first-party sales, which hurts overall revenue. So perhaps we can give it a temporary pass for the revenue drop.

Consider that non-first-party sales were up almost 19% in the third quarter, maybe more indicative of future prospects. But even if we give Jumia that 19% growth rate (still trailing Amazon) and add in the currently untapped opportunities (like monetizing JumiaPay, its fintech service), it seems Jumia is already generously valued at $3.3 billion.

People from Jumia look at a computer screen inside a building.

Image source: Jumia Technologies.

What market capitalization can tell us

Letting winning investments run over the course of years can yield extraordinary results. Thinking long term, legendary investor Charlie Munger says, "The first rule of compounding is to never interrupt it unnecessarily."

In a turbulent year that's seen Jumia stock surge almost 500% year to date, now's a timely moment to remind ourselves these kinds of annual returns are atypical. But if we patiently let companies compound shareholder value over years, then life-changing returns can result, as long as we keep holding.

By comparing Jumia's market cap to its addressable market, we see that it can compound shareholders' returns for a very long time at its current growth rate without hitting a ceiling. So if the company starts profitably growing revenue, it's a growth stock you can buy and hold for a long time.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.