TCS & Infosys SHAKEN by Accenture Downgrade? 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

Accenture was the most trending investment related topic last weekend on Google trends.

Why? Well, because Accenture has downgraded its revenue growth forecast for 2024 from 2-5% to 1-3%. In other words, it now expects to grow at 1%-3% instead of 2%-5%

Now, downgrades are not new. They are quite common. So, why is it that Accenture downgrade started trending so strongly on the internet.

Well, this is because it is feared that this downgrade will also hurt the growth prospects of Indian IT giants like Infosys, TCS, and Wipro.

In other words, any hopes of rebound in IT demand for companies like Infosys and TCS may have to wait.

The stock market expressed its disappointment in the form of a 3% decline in the share price of Infosys and Wipro whereas TCS fell by 1.5% last Friday. The weakness has continued this week as well.

Usually, such panic reaction by the stock market is a good opportunity for buying good quality stocks from a long-term perspective.

And Infosys and TCS certainly qualify as good quality stocks. Besides, while there could be near term pressure on growth and profitability, their long-term future is quite bright.

They not only have a significant growth runway ahead of them in their conventional businesses, but there is also a huge opportunity in the form of Artificial Intelligence or AI as it is popularly known as, waiting in the wings.

'The Indian IT sector is sitting on a goldmine," said Ankit Bose, head of AI, Nasscom. 'It is just about how deep we dig.", he added further.

A report jointly put together by Nasscom and McKinsey, has predicted that GenAI, one of the most popular forms of Artificial Intelligence, will generate an economic value of US$ 2.6-4.4 trillion annually.

A good part of this value can be captured by stocks like Infosys and TCS, provided they make the strategic changes needed to capitalise on this huge opportunity.

TCS currently trades at a PE of around 31x its trailing twelve-month earnings.

This is slightly better than its 10-year average of around 25x.

Thus, the 25% premium that investors are willing to pay over the historical multiple, could be because of the confidence they have in the company's ability to tap into newer growth avenues like Artificial Intelligence.

If the opportunity is indeed as big as predicted by Nasscom and McKinsey and if TCS manages to grab a decent chunk of it, the company can end up a significant wealth creator despite being available at a higher multiple of 31x.

However, if the opportunity is delayed or there is some execution issue from the side of TCS, the premium multiple given to TCS may disappear in no time.

Its rival Infosys is also going through the same situation. It is also trading at a multiple that's around 25% greater than its historical average PE multiple of around 20x.

Thus, both the stocks are available at a premium to their historical valuations. This is usually the case when investors expect the future to be better than the past.

Therefore, is the future of both Infosys as well as TCS better than their past? Or are investors wrong in assigning premium multiples to these companies?

Well, I really don't know the answer to this to be honest.

However, as value investors, it is our job to ensure that one is not paying a very high premium for a promise of a much better future. Optimism is good. However, we don't like the price that optimism usually produces.

A small 20%-25% premium over historical valuation is fine. However, if this premium approaches the 50% mark or goes significantly higher, then alarm bells should start ringing.

After all, no business is so good that it can't be overpriced and become a bad investment.

On the other hand, if Infosys and TCS correct significantly going forward because of news similar to Accenture downgrade, it can turn into a good opportunity to buy into the Indian IT story at a marked down price.

The risk reward then would be a lot more in favour of the investors. Yes, it is as simple as that, especially for good quality stocks like Infosys and TCS.

I will see you again next time. Goodbye and happy investing.