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Home > Business > Special

Strong rupee = bad news for IT stocks

Devangshu Datta, Outlook Money | May 08, 2006

Nicholas Darvas had a notably individual style of data-mining newspapers. He would buy The Wall Street Journal and chuck away everything unread, except the stock quotes. His opinion: only price and volume mattered -- important information would show up in the price.

There was too much in the way of conflicting information available on the other pages of the WSJ and he preferred not to be confused by information overload.

Darvas made his fortune in the 1950s and 1960s -- long before the digital era (though he did invest successfully in IBM, Xerox and Texas Instruments). There is a lot of more information around nowadays, but very few people would have either the nerve or the mindset to employ the same filter.

Darvas was not trained in any of the usual investment disciplines -- he didn't have a mathematical, economics or accounting background. He was a dancer by profession. Maybe that actually helped him filter out all the contradictions visible in the financial landscape. He saw the market in black & white; most of us see it etched in shades of grey.

A little knowledge always tempts you to try and make sense of contradictory snippets of information and construct jigsaws that fit them together. Sometimes contradictory information can help you to construct an investing model that seems unusual at first glance.

Here, for example, are conflicting bits of information connected together in a jigsaw that may or may not seem logical.

The rupee: Up or down?

The Credit Policy has held interest rates unchanged. As a result of the 'sit-tight' Credit Policy, the rupee has strengthened. There is talk of full convertibility -- I don't think it will happen any time soon, but convertibility norms will be further eased.

In that case, more forex is likely to flow in rather than out and that could lead to further strengthening of the rupee. At the same time, India is facing an increasing trade deficit due to the rise in international crude prices. A higher deficit could cause a weaker rupee.

Domestically, bank credit has grown alarmingly quickly and that leads to natural pressure on interest rates. The extra provisioning for housing loans has already led to banks hiking rates in this key growth sector.

If rupee rates rise, the currency effects could be unpredictable but it's likely to be bad. Higher rates may pull more forex into the bond market but that positive effect would be overwhelmed by the fact that returns from the stockmarket would drop.

There is far more forex parked in equities and derivatives than there is in bonds. It's unlikely that you'll get a huge flood into the bond markets -- the system isn't geared to enable it.

IT: Good prospects or bad?

A strong rupee adversely impacts the profits of IT companies and may affect their sales growth because it makes them more expensive. A weak rupee adds significantly to their profits and makes them more competitively priced in hard currency terms.

In terms of guidances and projections, the big three of Infosys, TCS and Wipro have come through with decent projections. Infosys sees very strong EPS growth (almost 100 per cent under US GAAP) through 2006-07 on the back of 30 per cent plus revenue growth. TCS and Wipro are confident about maintaining their margins while registering 30-35 per cent revenue growth.

If we look at the current valuations, the big three appear more or less fairly valued. They have trailing PEs ranging in the 33-42 range with TCS at the bottom (33), Infosys (36) in the middle and Wipro (42) at the top end. Wipro always gets a higher discount because there is less floating stock than with Infy or TCS, especially after the bonuses.

In the context of the current market, IT is under-valued. Many other sectors are trading at higher PEs. If this fiscal's projections are met, and history suggests that these will be, the PE to EPS growth ratios are all acceptable. TCS is at a PEG of about 1. Wipro is at about 1.1 and Infosys is well below 1.

It is the rupee's future that tilts the balance either way. If it dips 5-10 per cent, that would add a big dollop of comfort to holdings in these three stocks. I think the rupee will drop but opinion on this subject is far from unanimous.

If the current strengthening continues, IT is a less enticing investment. Is the rupee's strengthening a temporary phenomenon? Or is it a secular trend?

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Number of User Comments: 1

Sub: should i sell the big three co's stock

i've got stocks of all the three companies according this article? should i go ahead n sell them???

Posted by kartikeya



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