Caught in the slugfest between the bulls and the bears in the last two years from July 2022 to July 2024, the shares of Infosys have moved up and down umpteen times. In the process, shares have managed to eke out 18 per cent gain in this period (aided by the 7 per cent upmove in the last five trading days), yet widely underperforming the Nifty 50, which is up nearly 50 per cent in the same period. However, on one metric the stock is exactly where it was two years ago – trailing PE valuation. Mid-July 2022, Infosys traded at a PE of 27 times. Today, it trades exactly at the same level, at 27 times. The inference we can make from the stock’s underperformance in the last two years is that, investors overpaid then (bl.portfolio had warned of this in reviews of quarterly results). The inference we can make from stock’s valuation today is that investors are overpaying even more! Here’s why.
Reconciling the valuation dichotomy
Two years ago, when Infosys delivered Q1 FY23 results, the company reported year-on-year constant currency (CC) revenue growth of 21.4 per cent. Today, in its Q1 FY25 results, Infosys reported CC revenue growth of 2.5 per cent. Notice the enormous divide between growth two years ago and now? Yet company trades at the same trailing PE! Even when you consider valuation on a forward basis, Infosys forward PE in mid-July 2022 was 25 times, while it is 26.8 times today.
What exactly is the logic of valuing a company at 7 per cent premium (26.8 upon 25), when business conditions are significantly weak compared with two years back?
Sure, the Q1 FY25 results were better than expectations with revenue 2 per cent above consensus estimates, while EBIT was 3 per cent above. However, operating margins are flat at around 21 per cent compared with Q1 FY23 or with Q1 FY24. So not much progress on the margin front in recent years.
Revenue (CC) guidance for FY25 was increased from 1-3 per cent to 3-4 per cent, which implies increase in mid-point from 2 to 3.5 per cent. However, it is important to note that the increase in guidance now, includes the positive impact from an acquisition (in-tech, a ER&D services company). Excluding this impact, the year-on-year growth in CC revenue guidance roughly works out to around 2-3 or 3.25 per cent. The mid-point at 2.5-2.62 per cent is not much of an uplift from the earlier 2 per cent.
Considering these, while there might be a lot of buzz following Infosys results given the beat in revenue/earnings and increase in guidance, digging through the details, there is not much to get excited about. Management guidance apart, marginal reduction in headcount during the quarter (0.5 per cent), continuing weakness in North America (year-on-year CC revenue declined 1.2 per cent) imply a swift turnaround is unlikely. Further possibility of US recession, means investors must seek value before buying stocks like Infosys.
At bl.portfolio, we had recommended investors to book profits in Infosys in June 2021, when the stock was trading at ₹1,385. Since then Infosys has underperformed the Nifty 50, with 27 per cent returns compared with Nifty 50’s 60 per cent returns. As mentioned above, currently investors need to reconcile the logic of paying the same 27 times valuation for a low-growth stock compared with 27 times two years ago for a high-growth stock. When this exercise is done, the inference will be clear that the shares of Infosys are not attractive, although it might be a high-quality company. Hence, we recommend that investors wait for cheaper valuations before considering the stock for investment. It would also be worth noting that in the earlier decade, when growth was this low, Infosys used to trade at a trailing PE of 15 times.