Infosys enthusiasts say despite the challenges it faces, the earnings part is still intact in the price/earnings (P/E) multiple. What's missing, however, is the price. The company's shares might have been hammered for not meeting the market's sky-high expectations but it continues to generate profit.
Unfortunately, valuations are more about potential and not current performance, which is why the company's shares have been de-rated. At a P/E multiple of 14.5x one-year forward earnings, its shares are trading at a 20 per cent discount to Tata Consultancy Services (TCS).
In a bid to go up the value chain, Infosys stopped focusing on the applications and maintenance business. JP Morgan says: "The 'bread and butter' services which make up about 70 per cent of total IT services spending got ignored in an effort to grow consulting and system integration business. In a difficult market environment, 'bread and butter' services help drive revenue growth, where other large players such as TCS have better positioning." Analysts say the company lost market share in multi-vendor accounts as rivals offered better pricing.
But all these are known. What's new is that Infosys has done course correction. Analysts say Infosys is aggressively going after segments which are still seeing growth. For instance, the company's share in the overall infrastructure management services pie has gone up over the last quarter and it is also going after the deal renewal market. Infosys has been showing improvement on a sequential basis. Volume growth was 2.7 per cent in Q1 and 3.8 per cent in Q2. In the first half of the year, it won six large deals in excess of $1.4 billion in combined value.
Also, the growth rate of TCS is being looked at in the context of Cognizant's. TCS has added incremental revenue of $325 million over the past 12 months, while Cognizant has added $291 million. Despite being 40 per cent smaller, Cognizant's incremental revenue additions were only 10 per cent lower than those of TCS but it still trades at a 10 per cent discount to TCS.
Nitin Padmanabhan and Soumitro Chatterjee of Espirito Santo say: "It's difficult to see how TCS should command a further premium valuation to Cognizant. We expect Q3 will see a convergence in the revenue growth rates of Infy and TCS, which will reduce the gap in valuations, too." Also, Infosys is one of those stocks which has seen its stock price fall despite an earnings upgrade, making it a better play than peers from a valuation point of view.