October 20, 2010

A bear case on IT companies

It’s not that I have always been a bear on IT companies. I have held NIIT tech, Patni computers and Infosys are various times over the last 5-6 years.

You can see my analysis of NIIT tech
here and patni here.

The main reason for my bearishness is simply ‘valuations’. Mid cap companies like NIIT tech or patni and maybe a few others could be slightly undervalued (depending on your point of view), but I find it difficult to see the undervaluation in large caps such as Infosys which are selling over 30 times their current earnings.

A lot of the IT companies are priced for perfection which as we have seen never happens in reality. In the alternative universe of brokers and tipsters, the time to buy IT stocks was in 2000 and now and to sell was in 2008. We do not know how things will turn out in the future, but can clearly say from hindsight that 2000 was the time to sell and 2008 was a decent time to buy.

The advantage (or disadvantage) of having a blog for more than 5+ years is that all your past thoughts and statements are online and can be referred back at any time. In 2008, I felt that IT stocks, especially midcaps were extremely undervalued (some selling for PE of 2 or 3) and hence were a bargain. It was not a macro point of view, but based purely in valuations (you can read the post on it here)

Getting the timing wrong
My decision to start buying into some of the IT midcaps was based on valuations and a belief that the underlying economics of the IT service space was still attractive and the companies would continue to be profitable in the long run.

I had no clue that 2008 and 2009 would be such a disaster ( if I knew, I would have bought put options and retired by now :) ). So clearly, in hindsight the best time to buy was 2009.

However one cannot make investment decision based on hindsight and so mere mortal like me (unlike some of the forecasting gurus ) have to base their decision on current valuations and expectations of reasonable business conditions in the future.

Still no idea of the future
As I have still do not have any special powers of knowing the future, my current view on IT stocks is centered on valuations and some of the long term headwinds faced by the industry such as
- Dollar depreciation : when and by how much …who knows, but more than likely to happen
- Increased costs : If you are an employed with an IT company, a point to remember is that everytime you get a good raise in salary, it comes from the bottom line (no there is no santaclaus paying for your salary)
- Intense competition: From other IT companies which is likely to drive down returns in the long run
- Host of other factors: regulation, slow growth in developed markets etc etc

The point is that the current valuations do not reflect these risks. Ofcourse you can make a point that current valuations for a lot of companies do not reflect the risk – but that is whole different story.

So what to do ?
Nothing much – sell if you think the stocks are overvalued and yes, be prepared to look like a fool if the stocks keep zooming up after you have sold. I have done that for most of my IT stocks and I am fully ready to look like a complete fool.

18 comments:

Ranajit said...

Hi Rohit,
I was wondering if you have any thoughts on Zensar technologies. From my valuation perspective, it seems undervalued. It's been improving revenues for the past few years. It's cash position is pretty good and it's a zero debt company. The co. also bought back shares in Jan 2010 for Rs 165.

Wondering if you have taken a look at it?

Anonymous said...

Hi Rohit,

Have you uploaded valuation sheet for asian paints on google group?
How do you find the stock now?

mkd said...

Most large cap have been "richly" valued for quite some time now.

I have been pretty much of the same view for quite some time and accordingly not only sold my holdings but even dabbled a little in buying PUT options.

Ofcourse not only have I looked like a fool, but even lost some money to support the thesis :-(

However said that, it seems extremely risky to be in IT stocks due to uncertainity in global environment and the already sky high valuations.

The feeling is that if any risk materializes or system shock happens, it will not be a slow grind down for IT like 2007, but maybe more like a bungee jump of 2008.

For a PE to contract from 30 to 10-15 can happen faster than some people think.

anuragsayz said...

Hi Rohit,

I hold Hexaware and planning to get into 3Iinfotech.
Any thoughts on these two stocks

Neeraj Marathe said...

I agree..
valuations for stocks like Infy discount a very rosy future..
however, if the future does not turn out to be so rosy, the valuations (and stock price) will take a hit..
in effect, no MOS at current valuations
cheers!
Neeraj

rayhaan said...

hi rohit ,i guess u r right, i.t. Co's are indeed having stretched valuations, although there must be a few undervalued 1's out there. Wish there was some SAFE way to make money off this situation in India.
P.s. So what are ur views on d pioneer distilleries 'arbitarage'? And yeah, 4give me but i luv listening to d views of my favourite bloggers on the stocks i'm investigating....:)

Anonymous said...

Hi Rohit

Agreed that stocks r looking overvalued and even streched in somecase. What I am strugling with is that there is a constant inflow of cash (salary) and desire to make returns on it, there are not many fixed income instruments which will give decent returns (10% post tax)...so how does one earn returns...am strugling to find avenues to invest in which look safe...any thoughts

The Money Paradise said...

IT and software stocks are expected not to perform well in the cue of the stronger Indian rupee. it is a difficult time for the US dollar to remain strong against maximum traded currencies. and same is true with Indian rupee in the current market conditions. if some want to make money from these IT stocks please wait for while, these will fall. that time would be right time buy IT stocks.

Anonymous said...

looking for a good pharma stock
please suggest, have been looking into sterling biotech seems good but want your opinion.
regards
dhiraj

sandy said...

Yes, valuations are quite high but still there are some single digit p/e stocks like rolta. It is trading at a 52 week low with p/e of around 7. It seems worth investigating.

Rohit Chauhan said...

Hi ranajit
i had looked at zensar sometime back and came close to buying it. havent looked at it since then ..will do so

hi anon
no i havent uploaded any analysis for apaints in google groups. i seems fairly if not overvalued as of now. havent bought it for sometime

rgds
rohit

Rohit Chauhan said...

Hi mkd
welcome to small group of conservative investors :) ..people like you and me look like clueless fools during such raging bull markets.
i would rather look like a fool for some time than lose money by speculation

rgds
rohit

Rohit Chauhan said...

Hi anurag
i looked at hexaware in 2007-08 after they had the forex / derivative fraud. as i was holding enough IT stocks ..did not buy further. but i think it was quite cheap then

rgds
rohit

Rohit Chauhan said...

Hi neeraj
you hit the nail on the head ...thats the precise word for my long post :) ...no MOS on infy

rgds
rohit

Rohit Chauhan said...

hi rayhaan
unfortunately there is never a risk free way of making money in the market.

what is the thesis on the arbitrage situation ..can you email it to me ? rohitc99@indiatimes.com ?

rgds
rohit

Rohit Chauhan said...

Hi anon
i understand the predicament you have ..patience is essential ..sometime its better not to put money in the market in overvalued stocks to make a quick buck as the risk is too high

either keep looking for cheap stocks and invest in them if you can find some or else be cautious and do nothing.

unfortunately no easy answers here :)
rgds
rohit

Rohit Chauhan said...

Hi moneyparadise
agree with your comment ..but it is not easy to time the purhcase

hi dhiraj
i have not looked at sterling..have not competence in biotech ..i currently hold FDC which is a bit undervalued ...you can find the analysis on my blog

rgds
rohit

Rohit Chauhan said...

Hi sandy
had looked at rolta in the past ..was not very confident of the management and so gave it a pass

rgds
rohit