Infosys: Good to Buy?

On 22nd February 2012, I’d sent you a comprehensive research report on Infosys, as part of the StockTalk initiative.

The stock was then trading at Rs 2,940, and this is what my analysis told me to write to you…

…the fair value range for Infosys’s stock is Rs 2,740 to Rs 3,050. Assuming a margin of safety of around 20%, I would be comfortable buying Infosys’s stock at any price less than Rs 2,450…but not more than that.

Given that the stock’s current price of around Rs 2,940, I would wait for it to fall by around 15% before buying into the same.

That’s a good case of a great company, but not a great investment (at the current price).

So it is clear from the above words that while I was comfortable about Infosys as a business, I was not comfortable about Infosys as a stock as I believed its price was expensive (as I wrote – “…a great company, but not a great investment…”).

Anyways, as luck would have it, Infosys has fallen by around 20% since then, thereby coming under my comfortable buying price of Rs 2,450.

Data Source: Ace Equity
So, is now a good time – or let me say, a good price – to buy Infosys?

Before I answer that, first I need to recheck my original assumptions for Infosys and see whether the intrinsic value (of Rs 2,450) that I calculated then still holds good.

I need to answer this question – “What if I need to change my assumptions about Infosys’s future profits and cash flows given that the company’s management has itself talked about tough times in the future?”

I need to answer this because if I really need to change my assumptions i.e., lower them, I would even need to lower my intrinsic value estimates for the stock.

So, even after falling 20%, the stock might still be expensive.

Now why am I explaining all this and not coming straight to the point whether Infosys is a good buy at this price or not?

I am doing this as this should be your thought process when reviewing a stock that has fallen in price.

Instead of thinking – “I already did enough research on the stock three months back. Now since it has fallen 20%, I must buy it without wasting any time doing more research.” – review your assumptions for the business and see if they still hold true.

So, is Infosys a good buy at this price?
Before we get to that, here are five ways we used to arrive at Infosys’s intrinsic value of Rs 2,450.

1. Net present value based on a 2-stage 10-year DCF
2. Earnings Power Value (EPV)
3. Pricing relative to 10 year average P/E ratio
4. Graham number
5. Dividend discount model (DDM)

Three (2, 3, and 4) out of these five methods used data from the past to arrive at the respective intrinsic values. Now, since Infosys’s past cannot change, we don’t need to worry at all about these three calculated intrinsic values.

As far as the fifth method of DDM is concerned, given a few months do not bring about a sea change in a company’s dividend payment policy (at least not for a company like Infosys), we don’t need to get worked up on this number as well.

Thus, in the light of Infosys’s recent performance, the only assumption that needs to be reviewed is its DCF based intrinsic value.

You can find a good explanation of the DCF method in Infosys’s StockTalk report, so I will not discuss much here.

What I would however like to bring to your notice is that, while researching the stock in February 2012 plus after looking at the past 10-12 years data plus after making broader assumptions about the company’s long-term future prospects, I had assumed its cash flows to grow at an average rate of 15% for the next 5 years, and 12% for the subsequent five years.

These are reasonable long-term estimates for Infosys, even assuming that the company might continue to face rough weather in the short term.

Here are some historical charts that lead me to believe that Infosys’s future might not be as bad as has been made out by stock market analysts and other experts appearing on business media.

Data Source: Ace Equity
Of course, I must not try to draw a pattern just seeing the company’s past performance. But, as you must have seen in the StockTalk report, we covered the entire thing about the company’s core business strengths and challenges, and then came to a view that the business was indeed expected to be on a decent footing in the long term.

Even if we are to believe that Infosys’s prime is behind it – which indeed is a reasonable assumption – the company still has the wherewithal to grow at a decent pace in the future.

And 12-15% average annual growth in cash flows (over a 10-year period) isn’t an aggressive assumption anyways.

So despite the hullabaloo surrounding Infosys in the past 2-3 months, and despite a slightly weak performance by the company in the recent quarter, I see no reason to change my long term view on the stock.

In fact, Mr. Market’s madness is giving all sensible investors a good chance to buy the stock at a reasonably attractive price (after assuming a 20% margin if safety).

In fact, the stock is currently trading at around 23% lower than the higher range of our intrinsic value of Rs 3,050 calculated in February (so the margin of safety is now at 23%).

For a more conservative investor – someone who is more comfortable with a margin of safety of say 30% – the stock must still fall by another 10% to become a ‘good buy’.

But I believe that a margin of safety of 20% is comfortable for a company like Infosys. And thus, if I have some cash (which I don’t have, as I used it up recently towards investing in BLIL), buying Infosys at the current price makes good investment sense from a long-term perspective.

Can Infosys double your money in 2 years?
If you expect this to happen, I will call it irrational exuberance.

Based on Peter Lynch’s definition, Infosys is a ‘stalwart’ company.

So it will not be as agile in terms of sales and profit growth as a smaller company. Thus expecting more than 50-60% return from the stock over a 3-year period would be unreasonable.

Though I have no idea how much return the stock will give during this time frame, if I invest in the stock, my return expectation will be not more than 50-60% from a 3 year perspective. If this is achieved in 3 months or 15 months, I will sell the stock and look for a better opportunity.

But I know that when times are bad for the stock markets as a whole, I will be safer in the company of a stock like Infosys (if only I buy it at the right price…like the current price).