Infosys is down 5% from the day the results got released. Are you still struggling to understand why prices are falling down? Or how much more down fall to expect? We will give you the answers for those questions. But there was also other valuable insight revealed when you join those dotted lines. We did that for you.

There were two important information that we focused on while going through their reports. First, they raised their dividend payout ratio from 50% to 70%. Second, they will maintain that same payout ratio for 2017 – 18 financial year and will also payback Rs 13,000 crore capital back to shareholders either through dividends or buyback of the shares.

All media and analysts were more focused on the Rs 13,000 crore as it represents 20% of shareholders capital so far invested in this business.

This news is the culprit for all the downfall in its stock price. Let me explain this to you with the example. Have a look at the table below:

Year Start Equity ROE Profits Dividends % End Equity PE Ratio Stock Price
Year 1 Rs 100 25% Rs 25 50% Rs 113 10 Rs 250
Year 2 Rs 113 25% Rs 29 50% Rs 128 10 Rs 290
Year 3 Rs 128 25% Rs 32 70% + 20% capital Rs 110 10 Rs 320
Year 4 Rs 110 25% Rs 28 70% Rs 118 10 Rs 280

 

So imagine you started business with Rs 100 and you reported 25% ROE. You withdraw 50% of your profits as dividends and reinvest the remaining. The market is giving your business fair value at 10X PE. So your company stock price is trading at Rs 250. Second year you again reported 25% ROE and you did what you did in year 1. Your company stock price is trading now at Rs 290. But in the third year you decided to withdraw 70% profits as dividends plus also 20% of your capital which you had invested in this business so far. Your company stock price in that year was Rs 320. But because of the massive cash pulled out from the play the stock price in the fourth year had plummeted to Rs 280.

This is what is happening with Infosys. Infosys is struggling now to grow its revenue and earnings and with dividend policy of reinvesting 50% of profits back into the business is hurting its ROE. They are not seeing rosy picture in relation to their earnings growth in coming future. So to maintain their stock price in the market they decided to return that money back to the shareholders.

The pressure on their earnings growth is due to fast changes in their industry and also higher cost on visas or recruiting local talent. These extra costs are expected to hurt their margins and many questions are rising on their business model. Abolish of 457 visas by Australian government yesterday (skilled work visa to work in Australia mostly used by IT industry), it looks President Trump strategy on H1 – visas will be imitated by many western nations and deepening the margin pressure on all the Indian IT companies.

Indian IT sector represents almost 17% of the market and with the new changes going on in the world it looks the companies will lose their higher ROE standard which will impact directly to their business fair values.