A famous Warren Buffet dictum – ‘Price is what you pay, and value is what you get’ – is a good logic to apply while making investment decisions. No matter a company is strong or inefficient, chances of making returns that beat inflation, and even much higher CAGR returns over long term, depend on whether one buys a stock at an attractive price (relative to its fundamentals).
With over 50 per cent returns in the last one year , the stock of TCS appears expensive. In the previous one-year period (pre-Covid), consensus expectations for TCS were of low double-digit (10-11 per cent) revenue and EPS growth for FY21. It is now expected to end FY21 with low to mid-single digit percentage revenue and EPS growth. A 50 per cent return in that scenario only implies investors have looked well into the future in valuing the company. During the same period, the stock of industry leader Accenture which has also delivered good results is up only around 21 per cent. TCS, after always trading at a discount to Accenture over the last many years, now trades at a slight premium . There is no explicable reason for that.
As far as business performance is concerned, TCS has given a lot to be optimistic about its fundamentals. Given its size and scale (December quarter revenue is around 70 per cent of the combined revenue of Infosys, Wipro and HCL Tech), it getting the better of the disruption caused by Covid-19 shows best in-class operational excellence. The company is likely to close FY21 with near flattish constant currency (CC) revenue growth amid the worst global recession since World War II . This gives the confidence that it is building a recession-proof business model.
TCS remains a dominant player in digital services and it is making right investments to remain a vendor of choice in that space for clients. The company’s successful transition to the digital theme that gained steam in the middle of the last decade gives confidence that it has the agility and resources to ride evolving themes like 5G. With its December quarter results, the company also beat expectations across the board ( revenue in constance currency, margins and EPS) and sounded confident of delivering double-digit revenue (constance currency) growth in FY22. The conviction stems from strong deal traction in the recent quarters and broad-based demand improvement across verticals and geographies.
While TCS has been trailing Infosys in revenue growth since FY20,this came after it outperformed Infosys in revenue growth over the last decade. Also, TCS still leads the industry with margins of around 26 per cent vs Infosys’s 24 per cent.
Why book profit
The only thing discomforting about TCS is its valuation. The stock now trades at around 31 times its FY22 earnings(Bloomberg consensus estimates). Its mean PE multiple over the last 15 years is just below 20. While premium-to-mean is completely justified given its size, scale and history of consistent performance, these are strengths that markets had already acknowledged and priced in.
In the last couple of years into 2020, it was trading around 22-23x its one year forward EPS.
Based on current consensus expectations, its FY15 to FY23 EPS CAGR will be 10 per cent, which at best implies moderate long term EPS growth. Given these factors, it does appear its current valuation reflects some excessive market exuberance. If one were to take a 2 year view, even if the stock were to track its earnings growth, investors could still lose value in their investment if the PE reverts to around 22-23 times one year forward EPS.
So, a lot hinges on the current PE multiple holding up to make decent returns. That would require either interest rates to stay at current levels, market participants to continue to maintain their exuberance for a long period (both risky assumptions to make) or a substantial change in TCS’ business model that accelerates EPS growth (unlikely as of now).
For investors in India, buying a moderate earnings growth stock at forward earnings yield ( EPS/Market Price) of 3.2 per cent does not look attractive when two-year bank deposits yield 5-6 per cent. There is also risk that with Infosys growing better than TCS in the last two years, management may at some time have to consider compromising on margins to defend/gain market share. This may cause a lot of volatility in stock if it were to happen.
Hence, investors can sell and look to buy the stock after a decent correction (20 per cent or more). It being a high-quality company , the stock must always remain in investment radar and bought at lower levels when the opportunity presents.
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