Wait and watch
THE price earnings multiple of most frontline software companies have remained locked in a relatively narrow band over the past few months (occasional swings notwithstanding). This was in stark contrast to the sharp appreciation in the valuation of medium-sized companies. The relatively better and reliable flow of information have reduced the volatility in the frontline stocks vis-à-vis the speculative burst of activity in medium-sized companies. But do the fundamentals justify an entry into select frontline stocks at this point in time? These stocks can be avoided for now, as the risk-return paradigm has changed completely and the full impact of certain developments affecting the sector will become evident only over the coming months. The following developments will have a bearing on valuation:
First, before buying afresh or raising exposure in frontline companies, it may be better to wait for Infosys Technologies to outline its management guidance for 2002-03 on April 10. That will probably serve as a yardstick to judge other companies. The only inference we can draw at this stage is that if the revenue growth is pegged at 30 per cent or above, it may be a positive primarily because anything below that would take a toll on the future per share earnings growth.
Over the next nine months to a year, the immense potential for large-scale offshore outsourcing from Fortune 500/Global 1000 may not be fully realised. As indicated elsewhere, that is mainly because revenue buoyancy may lag the recovery of the US economy, decision cycles are likely to remain long, billing rates may remain under pressure till the overcapacity in the industry gets absorbed, and the technology over-investment spiral abates.
As the frontline players attempt to move up the software value chain, the business model is undergoing a significant change. It may take up to two years for the success of these plans to get reflected in the financial performance.
As the US stock market stabilises, it is likely that frontline companies will contemplate aggressive acquisition plans. But given the near-term uncertainties associated with these acquisitions, these stocks may be subject to extreme volatility; hardly desirable for small investors.
If Tata Consultancy Services makes its IPO this year, it could decisively swing the valuation of the sector and affect the valuation of several frontline companies such as Infosys, Wipro, Satyam and HCL Technologies.
Investment recommendations: For investors with a medium-term perspective, Infosys Technologies is recommended at Rs 3,200-3,300. However, it is best for investors (with varying risk profiles) to wait for Infosys to announce its revenue forecast for 2002-03. Even after providing for a healthy PEM differential over Infosys, Wipro may be appropriate only at Rs 1,350-1,450. Satyam Computers looks fairly attractive at the current level of Rs 267, but as it has not fully firmed up its plans to move up the software value chain, investors may be better off waiting-and-watching. It may be prudent to avoid investing in HCL Technologies and Hughes Software for now.
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