What should we do with HCL Technologies after its quarterly and full year results

Stock market is sitting at all time high and more than 100 stocks at all-time high. Investors are confuse what to do with their current holdings. Should they buy their favourite stocks at all time high prices? Or should they sell all of them and sit on cash.

So let us get back to the basics of investing and find some real opportunities this Monday morning. Ask any stock market pundit about how to make money in the stock market. ‘Buy low and sell high’ will be the advice. We also believe in that and we will go further and say that it is the only way to make money. But research say that 90% of all the investors do opposite. They buy high and sell low. Look into your own portfolio and find out where you belong. If you are in 10%, good on you! But if you are on the other side than you have to consciously make an effort to cross that line.

It looks easy and catchy when you hear that phrase but soon we find it very hard and realise how difficult it is to practice. We realise that while practicing same we are against the majority of investors in the market.

Nifty 50 at 9400 levels and I thought to look at those 50 companies and compare its stock prices against our calculated intrinsic value bands. Not to my surprise found three of the top four IT stocks trading within those band making them favourable to buy.

But not many including the readers of this article are confident to have exposure to these IT companies today. The sector is going through the systemic changes and companies will have to adjust their margins and profitability. But is there any sweet spot still available within this sector to invest? Well, we will find out soon.

So we are comparing TCS, Infosys, Wipro and HCL Technologies to find that sweet spot.

HCL Technologies is the only stock that has given positive return of 19.58%, Infosys -19.67%, TCS -5.89% and Wipro -5.73% in the past year.

Business Model

Before talking about the valuations of these companies let us compare their margins and profitability to understand the business model.

Margins Table

2017 HCL Technologies Infosys TCS Wipro
Revenues 48640.85 62,351 117,966 57,995.1
Margin % 100% 100% 100% 100%
EBT 10,542.75 18,938 34,513 11039.3
Margin % 21.67% 30.37% 29.26% 19.03%
Net Profits 8304.98 13,800 26180 8736.3
Margin % 17.07% 22.13% 22.19% 15.06%

 

You will find big difference in their business model. I will place Infosys and TCS in the similar business model but HCL Technologies and Wipro in 2 other separate business model. The biggest expense for all the four business is the human resource cost. HCL Technologies EBT margins are low because of the higher cost of employees hired in the USA. They realised earlier that the industry at certain point can face issue of visa constrain from the local government. To mitigate this risk they started investing long time back in building delivery outlets in USA.

On the other hand Wipro is aggressively acquiring new companies and broadening its investment horizon which is reflecting on its weak margins.

With the expected visa constrain from the USA government the street is worried about the profit margins of Infosys and TCS. The management of both the companies expect their EBT margins to shrink around 24% and their profit margins around 18%.

The sector is seeing a sluggish revenue growth in the coming year which is around 10% – 12%. That kind of growth with shrink margins and other headwinds will not grow their earnings. The street is not expecting growth in their earnings and are dumping stocks in the stock market.

But shrinkage of margins is the problem of Infosys and TCS not big issue for HCL Technologies and Wipro. HCL Technologies had already mitigated that by hiring and building local delivery outlets in the USA. So is there opportunity to invest with either of them?

Valuations

It is very clear to us that revenue growth for HCL Technologies and Wipro will give positive growth to its earnings. But Infosys and TCS might have to struggle a bit more to grow their earnings. Most of the analysts expect Infosys, TCS and HCL Technologies earnings to grow by around 8% and Wipro by 2% in the 2018 financial year. So according to them the weakest is Wipro and the strongest is HCL Technologies.

We have discussed TCS and Infosys numbers in detail on this blog earlier too.

We believe stock prices eventually in the long run follow the intrinsic value of underlying asset. So if the intrinsic value of the company is heading up every year consistently than price of stocks will follow behind them.

Have a look at the table below where we calculated the intrinsic value for 2017 for the four companies and the range of the stock price traded in the past year.

Stocks Intrinsic value 2017/ share Stock Price range
Infosys Rs 669 Rs 1279.30 – Rs 901
TCS Rs 2,248 Rs 2,744.80 – Rs 2,051.90
Wipro Rs 390 Rs 577.80 – Rs 408.10
HCL Technologies Rs 813 Rs 890.15 – Rs 706.40

 

Stock price for the Wipro and Infosys had traded above their 2017 intrinsic value past year. We can say that Wipro stocks at one stage came close to its intrinsic value but Infosys always traded at premium. The simple reason is the massive cash reserves of around Rs 25,000 crore sitting in Infosys bank account.

The management of Infosys had taken a right decision of giving back approximately Rs 13,000 crore back to its shareholders. This action will help its intrinsic value to rise at healthy rates in 2018.

Intrinsic values of the business changes as the year passes on. Similar to the stock price but at very slow pace. It is very crucial to know the valuation band for the near term future (year or two) which is calculated rationally to take decision at the time of investment. It gives the confidence and strength to stand up against majority of the investors who have opposite opinion to us. We calculate those bands considering both, bull and bear scenarios.

We ask investors to buy stock when they are trading within or below those bands. Buy more when the stock price is closer to the lower band (Bear scenario) and less or hold when they are close to upper band of valuations. Last year HCL Technologies threw one of the opportunity to investors to buy around Rs 707. If you would have bought at those prices than your would have been sitting on returns of 20% today.

Conclusion

So looking at our estimated 2018 intrinsic value band today, three out of the four stocks we are discussing in this article are trading within their intrinsic value bands making them attractive to invest. Infosys is the only stock which today is trading above its 2018 valuation bands.

Wipro’s stock price is trading very close to the upper band of 2018 valuations and TCS follows the next. HCL Technologies stock price is trading closer to its expected lower band intrinsic value for 2018 giving best opportunity to invest compare to its peers.

It will be not fair if I do not disclose my holdings in relation to this article. We hold HCL Technologies stocks in our portfolio but we are not buying any fresh stocks at this stage. Apart from valuations we also look for the growth stocks to invest with and HCL Technologies does not qualify as extraordinary business to invest with on that parameter. For us HCL Technologies is to hold.

What about you?