Will Accenture's Downgrade Drag Down Infosys and TCS?

Mar 25, 2024

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 Will Accenture's Downgrade Drag Down Infosys and TCS?

Accenture was the most trending investment related topic last weekend on Google trends.

The surge in popularity may have to do with the IT consulting giant downgrading its revenue growth forecast to 1-3% from 2-5%.

But downgrades are common you may wonder. Why did the internet make such a big deal of Accenture's downgrade?

Well, this is because the flames of this downgrade have reached the doorsteps of Indian IT bellwethers like Infosys, TCS, and Wipro.

They are threatening to destroy any hopes of a rebound in IT demand that these companies have been harbouring of late.

The stock market expressed its disappointment in the form of a 3% decline in the share price of Infosys and Wipro whereas TCS fell by 1.5% on Friday. This, even as the Sensex had a good outing, closing higher by 200 points.

Usually, such knee jerk reaction by the stock market is a fertile ground for buying good quality stocks from a long-term perspective. And when it comes to quality, there are few stocks better than Infosys and TCS.

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They not only have a significant growth runway ahead of them, but there is also a huge opportunity in the form of Artificial Intelligence or AI as it is popularly known as, waiting in the wings.

'The Indian IT sector is sitting on a goldmine," said Ankit Bose, head of AI, Nasscom. 'It is just about how deep we dig."

A report jointly put together by Nasscom and McKinsey, has predicted that GenAI, one of the most popular forms of AI, will generated an economic value of US$ 2.6-4.4 trillion annually.

A good part of this value can be seized by the Indian players, provided they make the strategic changes needed to capitalise on this huge opportunity.

TCS currently trades at a PE of around 31x its trailing twelve-month earnings.

This is slightly better than its 10-year average of around 25x. Thus, the 25% premium that investors are willing to pay over the historical multiple, could be because of the confidence they have in the company's ability to tap into newer growth avenues like Artificial Intelligence.

If the opportunity is indeed as big as predicted by Nasscom and McKinsey and if TCS manages to grab a decent chunk of it, the company can end up a significant wealth creator despite the premium multiple.

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However, if the opportunity is delayed or there is some execution issue from the side of TCS, the premium multiple given to TCS may disappear in no time.

Its rival Infosys is also going through the same situation. It is also trading at a multiple that's around 25% greater than its historical average PE multiple of around 20x.

Thus, both the stocks seem to be valued in a way that predicts of a future better than the past.

Whether it will come into being is anybody's guess. However, as value investors, it is our job to ensure that the current valuations don't reflect too much of a rosy future.

A small 20%-25% premium over historical valuation is fine. However, if this premium approaches the 50% mark or goes significantly higher, then alarm bells should start ringing.

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After all, no business is so good that it can't be overpriced and become a bad investment.

On the other hand, an overreaction to the revenue downgrade by Accenture in the form of a significant correction in their stock prices, should be seen as a good opportunity to buy into some of India's best businesses at a marked down price.

This may seem simple but trust me, it is not easy at all.

Happy Investing.

Warm regards,

Rahul Shah
Editor and Research Analyst, Profit Hunter

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