Shares of Tata Consultancy Services Ltd (TCS) closed at a record Rs690.45 on Tuesday on the National Stock Exchange. Less than nine months ago, they traded at Rs220 (adjusted for bonus), within striking distance of its all-time low of around Rs210.
Investor sentiment towards information technology (IT) stocks has indeed turned around rapidly. Early this year, it seemed like the industry would be the worst affected because of the global slowdown. Now, the outlook seems to be getting better by the day.
TCS’ shares are not alone in reflecting this. Infosys Technologies Ltd’s closing share price of Rs2,398.30 was within striking distance of its all-time high of Rs2,421. Leave alone Wipro Ltd’s absurd valuations during the technology boom of 2000 and it turns out that its shares, too, are near record highs last seen in early 2007.
Just in March this year, all of these companies were quoting at all-time low valuations in terms of earnings multiples. Given this dramatic turnaround, the pertinent question to ask is whether the rerating has been overdone?
Graphics: Yogesh Kumar / Mint
TCS, which has taken over from Infosys as the leader in terms of past price-earnings multiples among IT companies listed in India, trades at a trailing price-earnings multiple of 23 times. Infosys isn’t far behind with a valuation of about 22 times past earnings. This is far lower compared with valuations of well at least 30 times trailing earnings these companies have enjoyed in the past. In early 2007, for instance, Infosys traded at a past earnings multiple of at least 35 times.
But things have changed, and although the fall for Indian IT hasn’t been as bad as anticipated, growth rates from here on are likely to half of what they used to be prior to the crisis. India Infoline Ltd’s earnings estimates suggest that TCS’ earnings will grow at a compounded average growth rate of 15-16% in the three years between FY09 and FY12.
In terms of the PEG ratio (price-earnings divided by growth), therefore, valuations of IT stocks do look stretched. But then, valuations of almost the entire market is stretched, and given the lack of quality alternatives, investors are likely to latch on to these stocks given the turnaround in business fundamentals.
The September quarter results demonstrated that the worst is clearly over. A recent note by India Infoline points out that there are strong signs of a recovery in demand. “Lateral hiring, a leading indicator of volume growth, is picking up. After a lull of about 12 months, Indian and MNC vendors had full-page job advertisements in a popular newspaper,” it said.
What’s more, thanks to the slowdown, most companies had tightened their belts and should be able to protect margins despite a rise in the rupee and the salary hikes and bonuses paid to employees. It may be a bit too early to say IT firms are in a sweet spot, but one can’t refute the fact that things have turned around smartly, and this is what their stocks reflect.
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