Two IT giants reported their third quarter and nine month results for the 2016 this week. They both are investment quality business but we see a discrimination in valuing both businesses.

Let us have a quick glance on both the businesses results so far:

Infosys:

Infosys Q3 – 2016 Q3 – 2015 % change 9 mth – 16 9 mth – 15 % change
Revenues 15,902 13,796 15% 45,891 39,908 15%
Gross Profits 5,912 5,334 11% 17,054 15,199 12%
Operating profits 3,959 3,689 7% 11,400 10,383 10%
Other Income 802 840 -5% 2,353 2,546 -8%
Net Profits 3,465 3,250 7% 9,894 9,232 7%
EPS 15.16 14.22   43.29 40.39  
Dividends paid Rs 10 per share     Rs 10 per share    

 

TCS:

TCS Q3 – 2016 Q3 – 2015 % change 9 mth – 16 9 mth – 15 % change
Revenues 27,364.01 24,501.14 12% 80,197.60 70,428.65 14%
Gross Profits 11,083.53 9,797.84 13% 32,300.04 28,252.77 14%
Operating profits 7,230.13 6,586.15 10% 21,261.76 18,872.40 13%
Other Income 694.18 643.91 8% 2,136.86 2,093.69 2%
Net Profits 6,083.39 5,327.55 14% 17,878.70 16,139.51 11%
EPS 30.88 27.20   90.74 82.40  
Dividends paid Rs5.50 per share     Rs 16.50 per share    

 

The numbers of both the businesses looks in good shape and are performing consistently. Infosys is trading at 19.66 PE ratio on the expectations that Infosys will report Rs 58 per share as earnings for this financial year. TCS on the other end trading at 18.54 PE ratio on the expectation that they will report their 2016 earnings Rs 122 per share.

Infosys will report its return on equity for the 2016 to be 23% and TCS will report 46% for the same year. If we pull out cash that these two companies hold then there is no massive difference between their return on equity.

To understand these complex numbers from valuation point of view, assume you started with Rs 100 business called Infosys. The management invested Rs 40 in the business and are holding Rs 60 in their bank. They are expected to report profits of Rs 23 and are expected to give Rs 7 as dividends and reinvest remaining Rs 16 back in the business. The asking price to buy this business is Rs 452 for this business.

Another business with the name TCS was started with same Rs 100, of which the management invested Rs 65 in the business and are holding Rs 35 in their bank accounts. They are expected to report Rs 46 as profits of which they will be distributing Rs 9 as dividends with the shareholder. The asking price for this business is Rs 852.84 today in the market.

Looking at the numbers we think that TCS is trading at very expensive pricing but the key is to understand the earnings growth as well incremental return on equity that will be reinvested.

We think TCS is trading at almost 10% discount to its 2016 intrinsic values and do also see a little less discount on Infosys too.

We do not hold either of the businesses in our portfolio.

Aziz Dodhiya is the chief investment officer for the Valueoperations funds which operates in the Indian market as an FPI (Foreign Portfolio Investor). We do not offer any personal advice to buy or sell any stocks and the views that are shared by Aziz might not incline to your personal investment strategy and this is the reason we advise to take professional advice before going ahead with our views.