IT firms' valuations at 9-year low

29 listed firms are trading at 16.2 times trailing 12-month net profits against 18.8 times past year

The bulls have virtually given up on the IT sector. The price to earnings (P/E) multiple of top-listed IT companies has hit a nine-year low, only a little better than the previous record low in March 2009. 

The 29 listed IT companies that are part of BSE 500, BSE mid-cap and BSE small-cap index are now trading at 16.2 times their trailing 12-month net profits, down from 18.8 times a year ago. The sector had hit a trough during the post-Lehman crisis sell-off when the valuation reached an all-time low of 10.6x at the end of March 2009. 

The earnings multiple falls further to 15.3 when market capitalisation is adjusted for cash and equivalents lying in the books of IT companies. At the end of FY16, the industry was cumulatively sitting on nearly Rs 1 lakh crore worth of cash and liquid assets equivalent to nearly 10 per cent of their current gross market capitalisation of around Rs 10 lakh crore.

In comparison, broader market has become expensive in the last two years, making the IT sector one of the cheapest sectors on the bourses. The valuation gap between IT and the rest of the market is at its widest level since Tata Consultancy Services (TCS) got listed on the bourses in 2005.

The sector is even cheaper on price-to-book value basis, another key valuation matrix. IT companies are currently trading at four times their book value, down from 5x a year ago and slightly ahead of the record low of 3.1x at the end of FY09.

The analysis is based on the financial year-end market capitalisation, net worth and net profit of the listed IT companies since financial year 2004-05. The broader market data is for the common sample of 650 companies from BSE 500, BSE mid-cap and BSE small-cap index, excluding banks and financial companies.

Experts attribute it to lack of investor appetite for IT stocks given the protectionist stance of the Trump administration in the United States, industry’s biggest market. “Industry’s growth prospects are quite bleak, with the Trump administration tightening visa norms for techies on short-term visa,” says G Chokkalingam, founder and chief executive officer, Equinomics Research & Advisory.

Investors’ fears have been proved right as nearly stagnant growth was reported by the industry during FY17. For example, Infosys net profit was flat during the March 2016 quarter and rose only 6.4 per cent during FY17 on year-on-year basis, growing at the slowest pace in seven years. TCS also reported a lackluster result during the fourth quarter of 2016-17. 

Among top-tier IT companies, TCS remains at the top of the valuation chart with P/E multiple of 17.5x, while Infosys, Wipro and HCL Tech are all trading at around 14 times their trailing 12-month earnings. In fact, on price-to-book value basis, Infosys and Wipro, two of the oldest-listed IT companies, are now cheaper than what they were at the peak of post-Lehman sell-off. They were valued at 2.9 times their book at the end of September 2016, lower than 3.1x at the end of March 2009.

Not surprisingly, Chokkalingam now sees value in IT stocks. “I think the sector is at the bottom of its valuation cycle, and it should start moving at the first whiff of good news. The sector could also become a safe haven if the market gets volatile, given the strong balance sheet of top IT companies,” he says.