5 Things About TCS that Smart Investors Know

When you think of the best companies in India, then Tata Consultancy Services (TCS) would be among the first that comes to mind...perhaps the very first one.

In fact, even in the Indian stock market, TCS is considered to be among the best stocks to own by most investors and market experts. Almost every fund manager and many retail investors have the stock in their portfolios.

And for good reason. TCS is perhaps the bluest of bluechips in the Indian stock market. It has a great reputation for management quality, growth, profitability, and strong fundamentals. It's also pays consistent dividends stock and is among the best largecap dividend yield stocks in India.

So what is it about TCS that has created such an invincible aura around the stock? Why do so many investors, big and small, maintain such strong faith in the stock and will continue do so for a long time?

In this article we will uncover the answers...

#1 Smart Investors Appreciate Stability

The Indian IT sector has gone through a massive disruption over the last three and a half years. Ever since covid hit, these companies have had to restructure the way they do business.

These changes included, but were not limited to, the following:

• Creating, and then slowly reversing, work from home policies.
• Balancing project deliveries with hybrid work.
• Training employees to meet new technical challenges like artificial intelligence (AI) and (ML).
• Creating new incentives for employees in an era of record high employee attrition.
• Staying relevant to customers in the AI era.
• Maintaining growth and market share.
• Delivering good profit growth amid serious cost pressures.

It's safe to assume that the last few years have been the most challenging for India's IT sector.

And guess which company has handled these challenges the best among India's IT giants?

Comparing the FY23 numbers of TCS with its FY19 numbers (the pre-covid year), we see sings of stability all over.

Revenue has grown at a stable 11.4% CAGR. Net profit has grown at a stable 7.6% CAGR. Not extraordinary but stable.

And despite the ongoing cost pressures, the company's net margin in FY23 was a respectable 18.8%.

#2 Smart Investors Know 'When the Going Gets Tough, the Tough Get Going'

The best companies in every industry come out of a crisis stronger than when they went into it.

They gain market share from their peers. Their bargaining power over suppliers goes up. And most importantly, they can raise prices of their products and services.

How this happens specifically, varies between companies and industries. But the result is the same, a company with a stronger position in the industry.

This is evident in the case of TCS. The company's return on equity (RoE) has improved to 46.8% in FY23 from 35.3% in the pre-covid year of FY19.

This has not happened due to the company taking on debt. The company is among the debt free companies in India. It's not because of higher margins either. The net margin has actually reduced a bit due to the very high employee cost pressure in the industry.

The improvement in RoE is due entirely to the company using its assets better. This is as a result of its in-house developed intellectual property, its investments in new technologies like AI, and an increase in pricing power.

The best thing for TCS is that it doesn't actually have to increase the price of its services. It can instead, charge the same price to win larger and more significant orders. This helps to increase the 'stickiness' of the business. This in turn helps improve cash flows.

And that brings us to the next point.

#3 Smart Investors Understand that Cash Flow is King

You may have heard the phrase, 'cash is king'. In business, it's actually cash flow that is king.

No matter how high a company's revenue or net profit might be, at the end of the day it's cash flow that matters.

Investors want a return on their investments in the form of cash. This is in a combination of higher dividends, regular share buybacks, and a higher share price. All three are a result of rising cash flows in the business.

Here we refer to the term 'cash flow from operating activities'. This number is found in the cash flow statement which can be found by reading a company's annual report.

The cash flow from operating activities of TCS has grown from Rs 285.9 bn in FY19 to Rs 419.6 bn in FY23, a CAGR of 10.1%.

This is a solid annual growth rate of cash flow for a giant company like TCS. And it's no wonder that TCS is called a cash generating machine. This increase in cash flow has enabled the company to reward shareholders handsomely.

#4 Smart Investors Place High Importance on Dividends and Buybacks

Share prices can go up or down in the short term. They can also remain stagnant or rangebound for a few years.

However, a company's share price will always go up in the long term as long as its cash flows are growing and its competitive position is solid. These are true in the case of TCS. Thus shareholders are not too concerned about the short term movements of the stock price.

They have another reason to not be concerned about the stock price. The company regularly and generously returns cash to shareholders.

The company's dividends have increased from Rs 30 per share in FY19 to Rs 115 per share in FY23. Its dividend payout ratio - the percentage of the net profit paid as dividend to shareholders - has increased from 35.7% in FY19 to almost 100% in FY23.

Thus we can say that TCS is generating more cash than it needs to fund all its operations. It's business won't be negatively affected if it shares all its annual profit with shareholders as a dividends.

Then there are buybacks too. Just this month, TCS announced a buyback. This is the latest in a series of buybacks. The company has undertaken record breaking buybacks over the years.

We can get a good sense of the massive amount of money TCS returns to shareholders in the form of dividends and buybacks when we look at the term 'cash flow from financial activities' in the company's cash flow statement.

This is the amount of funds transacted as in loans, dividends, buybacks, equity fund raising, etc. It's basically all the money going in and out of the company in a given year.

In the case of TCS, this number is always negative which is a very good thing. It means the company is paying its shareholders well and has no need for external funds.

Most of the company's operating cash flow is actually free cash flow. So it pays out most of the cash it generates from operations.

The cash flow from financing activities, which is mostly the amount of cash being returned to shareholders annually, has increased from Rs 279 bn in FY19 to Rs 478.7 bn in FY23, a CAGR of 14.5%.

So what is the company's secret? How has TCS managed all this in a difficult environment?

This brings us to the last point.

#5 Smart Investors Invest in the Management as Much as the Business

In an ideal business, the management would not be capable of ruining the business. As Warren Buffett once said, 'Find a business that an idiot can run because some day, an idiot will'.

Unfortunately, most businesses are not so simple. Most businesses today need highly competent senior management teams to guide and grow the business in the dynamic and disruptive times.

This is certainly the case in the Indian IT sector. If an IT company's doesn't have a good management team at the helm, it's likely to die a quick death.

Shareholders of TCS have had the comfort of knowing that the team leading the company is among the best in the country...some would argue, among the best in the world.

Even after N. Chandrasekaran left to helm the Tata group as a whole, the company has been run well.

The senior level attrition is quite low in TCS and the company has never had a problem filling key positions. This is because of the company's reputation as a good place to work as well as the prestige of working for a Tata company in a leadership role.

It was for good reason the late Rakesh Jhunjhunwala said, 'The house of Tata is blessed by God.'

And as TCS is the 'jewel in the crown' of the Tata group, it's not surprising that the company's senior management team has always been excellent.

Thus, we see why smart investors have shown faith in TCS and will likely do so in the future as well.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...