While doing comparative analysis of Infosys and Wipro, in the first article of the series, we talked about the revenue distribution of the two companies. We also talked about the difference or similarities in client focus. In the second article, we talked about the business strategies adopted by the companies in the past. Then, in the third article , we compared them on the basis of their present business strategies, management quality and some of the financial performance parameters. In this article, we are going to compare Infosys and Wipro on the basis of returns generated by these companies to their shareholders and their valuations.
Please note that so far, for the sake of apple-to-apple comparison we had referred only to Wipro's IT services business which contributes around 75% of the company's total revenues. In this article, we are going to discuss shareholder's returns and the companies' valuations. In this regard, taking total business of the company into account makes more sense. After all, shareholders own all business segments of the company irrespective of their size or contribution to the total revenues. And therefore get affected by the performance of the whole business. Besides, stock markets value the whole business, not just one part of the business.
Return of Equity
A very important metric to measure shareholder returns is return on equity (RoE). On this front, Infosys is way ahead of Wipro. Average consolidated RoE for last seven years is around 36% for Infosys as compared to around 30% for Wipro.
On the back of higher margins at operating levels and rock solid balance sheet, Infosys generated better returns for its shareholders as compared to Wipro. At this front, Infosys seems to be a clear winner.
It is clear that Infosys has been generating higher returns on equity. But the question now is how are investors valuing these higher returns? Considering all the positive factors discussed so far, one should expect Infosys to command higher valuation multiples as compared to Wipro. However, that does not seem to be the case if we look at the following chart.
Source: Ace Equity Database
You must be surprised to see the earlier trend when Wipro used to command higher price-to-earnings (P/E) multiples. You may wonder as to the reason for the same.
The historical Wipro's premium valuation has nothing to do with the financial performance or any sustainable competitive advantage of the company. It was primarily due to the low liquidity in the stock. Wipro remains, in spirit, a closely held company. Its promoter Mr Azim Premji, along with family and friends, used to control around 84% of the company's equity during 2004. That created a kind of liquidity crunch for the big investors, especially of the institutional variety. These investors had to pay a premium to own the Wipro stock. By comparison, the Infosys stock was more readily available to the public, as its promoters, led by Mr N.R. Narayana Murthy, had just around 22 per cent of the company's equity during 2004.
This valuation gap was unsustainable and had to come down with the increase in liquidity in the Wipro counter. Gradually promoters' holding in Wipro came down to around 78%, at the end of March 2012. In the past 4 years, Infosys traded at an average of 17% higher P/E multiple than that of Wipro. And considering the quality of business the higher valuations of Infosys appears to be quite justified. Besides, 25% of the Wipro's business is non-IT services which in general commands lower P/E multiple. This is also an important reason for Wipro's lower valuation multiples.
What lies ahead?
Well, both the companies are currently feeling the heat due to the prevailing uncertainty in the global demand environment. Both the companies had to face the management issues in recent times. Wipro seems to be doing well under the new regime after dismantling the joint CEO model. Infosys has been a professionally managed firm. And it is expected that the new management team would continue the company's spectacular growth story once demand environment stabilizes.
At present, both the companies seem to be following similar strategies to grow their business in the future. Undoubtedly, Infosys is a bigger brand and a notch ahead of Wipro. But will that trend continue in the future? Only time can answer this question.
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