tcs, and $1 trillion

TCS has defied odds; there is no denying. I compared both Infosys and TCS in July 2013, and noted how things changed since 2009 in favor of TCS. In October 2013 when TCS hit $65 b in market capitalization, I wondered whether it was worth it based upon its fundamentals. Then came July 2014 when TCS equity was priced by the markets at $85 b, and I was skeptical again. Now it is a $100 b company. In fact, this report had actually predicted it would. I only hope that the author had put his own cash into his thoughts. 

Sure it is a $100 b firm; so what? What can investors do about it, buy more, or book profits? That's the question. If you read this report, the stock has the potential to rise 10 times, and become a $1 t company. Yeah, that's $1,000 b; isn't that great? For record, there isn't any $1 t company on the planet, not yet. 

TCS had net earnings of Rs.258 b ($3.9 b) for 2018. Let's keep the math simple rather than going into complex predictions. That implies a PE multiple of 25 times as of now. The report says, does not predict, that in 8 years TCS could become $1 t company if it grows at 33% annually over the period.

The author is right. If earnings grow at 33% and the multiple remains at 25 times, it's a $1 t math. But then, if the multiple goes up to 30 times, it will be $1.2 t; or if earnings grow at 25% over 8 years, the market value will be $600 b, keeping the multiple intact. 

We have to remember that a 25 times earnings multiple after 8 years will mean that the business will have strong expectations of earnings growth in years beyond. That implies, TCS has the potential to become much more valuable than $1 t. To see why, let's assume earnings growth of 33% in 8 years, but also assume that the growth rate will taper, and therefore apply a lower multiple of say, 15 times. Now the business will be worth close to $600 b. 

You see what I mean? Math is not the value driver. The value drivers are cash flows and growth, and expected rate of return. 

And there is always the justification. 

In 2009, TCS market cap was as high as Rs.1,034 b and as low as Rs.406 b. In 2009, its earnings were Rs.52.5 b, and for 2018, they were Rs.258 b. The earnings multiple implied in getting a value of Rs.520 b in 2009 is about 10 times. 

Let's do the math again. If the markets knew that TCS would grow at a very high rate from 2009 to 2018, the multiple would have been more than 10 times; let's keep at 25 times. At our new assumed multiple, the market value of TCS equity based upon 2009 earnings would be Rs.1,312 b. That gives us annual growth rate of 20%, not 33%, from 2009 to 2018 for market prices. 

Now even if we apply 22% growth rate in the next 8 years, and give a multiple of say, 15 times, the market capitalization of TCS would be $300 b; we are keeping the currency rates constant. There are two problems with this prediction too. One, it is much easier for Rs.278 b revenues (2009) to grow at 22% than for Rs.1,231 b revenues (2018). It is called the base effect. In fact, the actual revenue growth during the period was 18%. And you know what, TCS revenues grew by 4% for 2018. Two, we are all hopeless in making predictions.

This is how I see it: TCS has been a great business, and ably managed; and in all probability, it will continue to be one. But it is preposterous to assume a large growth rate going forward; and 33% growth rate is outrageous. The business challenges are very different from what they were a decade ago. The Indian IT firms will have a drastic makeover and shift in focus to do if they are to remain relevant and profitable in the coming years. And this itself is a huge headwind.

As I always say, time will tell.