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Software: Not just an EPS story - Views on News from Equitymaster
 
 
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  • Jun 25, 2003

    Software: Not just an EPS story

    Indian software companies, when compared on a global scale, are of a miniscule size. For example, the combined revenues of Infosys and Wipro in FY03 amounts to just about 2% of IBM’s total revenues (US$ 81 bn)! Though the Indian majors are small in revenue terms, in terms of returns to shareholders, they are far ahead compared to the likes of IBM and Microsoft.

    In terms of vision of the management, be it Infosys, Wipro, IBM and Microsoft, they have been trendsetters in their own ways. But at the end of the day, a company has to create wealth for its shareholders. Return on Assets (RoA), Return on Investment (RoI), and Return on Equity (RoE) are effective tools to measure the same. These ratios, as shown in the table below, are widely regarded as the ultimate measure of corporate performance.

    Since the software sector is dynamic in nature (owing to rapid technological developments), it is of significance to view returns not only from a historical perspective (i.e. 5 year average) but also in the most recent past (trailing twelve months - TTM). Admittedly, the last four quarters have been difficult of the software sector globally. Despite this downturn, firms like Infosys, Microsoft and Wipro have managed to maintain return ratios close to their 5-year average, as can be seen from the table below. At the same time, Satyam has been a laggard.

    India scores…
    (%) Infosys Wipro Satyam IBM Microsoft
    Return on Assets (TTM) 26.9 20.2 12.1 5.5 11.6
    Return on Assets (5 Yr. Avg.) 29.1 20.7 21.8 8.0 16.5
               
    Return on Equity (TTM) 33.5 24.7 14.4 23.4 15.0
    Return on Equity (5 Yr. Avg.) 35.3 29.4 35.6 33.5 21.5
               
    Return on Investment (TTM) 33.5 24.4 14.3 10.9 14.3
    Return on Investment (5 Yr. Avg.) 35.3 28.9 28.3 14.4 20.9

    Besides, the table above shows that Indian software companies have outclassed global majors on the returns front.

    What is the conclusion that a retail investor should derive from this analysis? That higher growth in revenues and net profit need not be the basic premise of investment decisions. For the short-term, even a high-flying management with lack of vision and zeal can give higher returns to a company’s stakeholders. But for these returns to be more sustainable and growing, what is required is a long-term perspective, a vision from the management. As we mentioned earlier, this is of great significance in as dynamic a sector like software services. The management’s ability to foresee trends and position themselves ideally to capitalize on those, will separate the top rung companies from the also rans.

     

     

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