Stock Idea: HCL Technologies – Steady performer

HCL Technologies Composite Valuation Indicator

Main Points

  • Fourth largest software services company in India
  • Consistent performer in the last decade
  • Announced it will consider share buy back of Rs 16,000 crore
  • Announced it will acquire a German-based IT and engineering services provider, H&D International Group to strengthen its position in the German market
Name of Company Country of Origin/ Exchange Traded Sector Stock Price Target Price
HCL TECHNOLOGIES LTD India/
BOM
Technology – Application Software – Information Technology Services INR992.50 INR1196.43
@ 25 Jul 2018
COMPANY PROFILE HCL Technologies Ltd provides a range of software services, business process outsourcing, and IT infrastructure product and management services in India, US, and Europe.

HCL Technologies provides enterprises with IT solutions in India. The company focuses on offering Digital, Internet of Things Services, Cloud, Automation, Cybersecurity, Analytics, Infrastructure Management, and Engineering Services to solve business problems for clients. While the company is based in India, it has international clients in a large number of countries. The company offers solutions to a variety of industries including Financial Services, Public Services, Consumer Services, Healthcare, and Manufacturing. The company emphasizes consultation services for firms, with the goal to offer them digital and design solutions.

Stock Code HCLTECH
Annual Dividend Yield 1.7%
Market Capitalization INR1.38 trillion
SUMMARY
Valuation Based on the Composite Valuation Indicator, the stock has a Target Price of INR1196.43 within a 12-month period. Our Target Price represents upside of 20.5% based on stock price of INR992.5 as at 25 Jul 2018.
Growth EPS Growth for the company is neutral.
Financial Condition The company’s financial condition is very strong.
Quality of Earnings The quality of the company’s earnings is high.
Operational Efficiency The company’s operational efficiency is neutral.

HCL Technologies Overview

Valuation
ProThinker believes in using a combination of valuation methods to arrive at a suitable valuation for the stock. This is because while each valuation method has its benefits, it also has its shortcomings. Price to Earnings and Price to Cash Flow Ratios are meaningless when the comany has negative earnings or cash flows. Price to Sales Ratio is more stable because sales are never negative. However, this does not tell us whether the company is able to sell profitably. Price to Book Ratio gives us an indication as to how much we are paying for the company’s assets but it is not directly related to the company’s profitability.
While it is important to value stocks based on multiple indicators, they sometimes lead to differing views on valuation. That is why we use our proprietary Composite Valuation Indicator, which gives you one conclusion based on the best combination of the different indicators, to tell you whether a stock is under or over valued. The graphical format allows you to determine whether or not the composite valuation accurately values the stock and gives you confidence to act on the decision.
In addition, we go all the way back 20 years (or as much as information is available) to give you a meaning “average” valuation of the company that takes extreme periods of the dot.com bubble and global financial crisis. Without this long a period, you won’t know the extreme highs and lows and therefore will not be able to determine the norm.

HCL Technologies PE

The Price Earnings (PE) Ratio is the most frequently used valuation indicator for a stock. However, there are times when this ratio cannot be used e.g. when the company reports a loss or profit is so minimal that it results in an abnormally high PE Ratio. Or Net Profit After Tax may be volatile and it is better to use Earnings Before Interest and Tax (EBIT) to value the company. We use the PE Band or Market Cap/EBIT Band to show whether a stock is overvalued or undervalued based on its historical valuation.
At the price of INR992.50 as at 25 Jul 2018, Hcl Technologies Ltd is trading at a PE Ratio of 15.4 times last 12 months earnings.  This is a 1.8% premium to its historical average Price to Earnings Ratio of 15.2 times. (Price based on the historical average PE of the company is indicated by the red line.)

HCL Technologies Price to Sales

The Price to Sales Ratio is another commonly used valuation indicator for a stock. It overcomes some of the limitations of the Price Earnings Ratio in that it can be used even when the company is not making a profit or only making minimal profits. However, it should not be used by itself because a company may be achieving sales but not profits.
At the price of INR992.50 as at 25 Jul 2018, Hcl Technologies Ltd is trading at a Price to Sales Ratio of 2.6 times last 12 months sales.  This is a 3.0% premium to its historical average Price to Sales Ratio of 2.6 times.

HCL Technologies Price to Cash Flow

Price to Cash Flow is an alternative method to value shares. This is because accounting profits can be subject to manipulation. Therefore, some investors prefer to value a company based on cash flows generated by the operating activities of the company. It also acts as a reality check to valuation measures such as Price to Earnings and Price to Sales. If a company generates high profits and sales but not operating cash flows, it could be heading for trouble because it is cash that pays the operating expenses. However, the Price to Cash Flow ratio of most firms are volatile and should not be used in isolation to determine the valuation of the stock.
At the price of INR992.50 as at 25 Jul 2018, Hcl Technologies Ltd is trading at a Price to Cash Flow Ratio of 14.7 times last 12 months cash flow.  This is a 1.0% premium to its historical average Price to Cash Flow Ratio of 14.6 times.

HCL Technologies Price to Book

Price to Earnings, Price to Sales and Price to Cash Flow ratios all value a company based on what it is generating (i.e. profits, sales or cash flow). Price to Book ratio is different in that it values a company based on what it owns (i.e. its net assets). This is usually a suitable valuation indicator for a financial institution, which frequently revalues its assets and liabilities, or a company with huge asset base e.g. utilities company.
At the price of INR992.50 as at 25 Jul 2018, Hcl Technologies Ltd is trading at a Price to Book Ratio of 3.6 times current book value.  This is a 5% discount to its historical average Price to Book Ratio of 3.8 times.

HCL Technologies Dividend Yield

For stocks that have a history of paying meaningful dividends, the stock price is often dependent on how much dividend the company pays.
At the price of INR992.50 as at 25 Jul 2018, HCL Technologies Ltd is trading at a Dividend Yield of 1.7%. This is a 18.2% premium to its historical average Dividend Yield of 2.1%.  (Note: The lower/higher the dividend yield, the more expensive/cheaper the stock is.)
Everybody has his favourite valuation indicator. Although most people would use Price to Earnings Ratio to value stocks, others believe that profits are open to manipulation and Price to Cash Flow is a better measure. Yet others rely on Price to Sales Ratio to value companies as this measure can be used even at times when the company is not profitable. Another way to value companies would be to value its assets and typically the Price to Book Ratio is used for that. Income investors who invest mainly for dividend income like to use the Dividend Yield to find companies that are undervalued.
We believe that each of these methods has its pros and cons. Therefore, we reckon that the best way is to use all five indicators and let empirical data find us the best possible combination of these five indicators that explains the stock’s price.
To find out more about our valuation methodology, click here. 

HCL Technologies Composite Valuation Indicator

Using a combination approach, we found a Composite Valuation Indicator that explains the stock price better than any of the standalone indicators above. And it gives you one signal to decide whether to buy, hold or sell the stock. The problem with using different standalone indicators is that they may give you different signals. Some may tell you it is overvalued while some tell you it is undervalued. This is no help to an investor who must make a definite decision whether to buy, hold or sell the stock.
Based on the Composite Valuation Indicator, the stock has a Target Price of INR1196.43 within a 12-month period. Our Target Price represents upside of 20.5% based on stock price of INR992.5 as at 25 Jul 2018. The target price takes into account the appropriate valuation of the company and its future fundamentals i.e. profit, sales, cash flow, book value, dividends, etc.
We recommend that investors start to take profit after upside of 15%.
Other Considerations
Of course, in deciding whether or not a stock is attractive, it is more than determining its valuation and future fundamentals. We need to consider other aspects of the stock such as growth, earnings quality, financial condition, operational excellence, cash flow, technicals, etc.
It is difficult to find a stock that is attractive valued and still pass every single criterion of the investor with flying colors. At times, we need to make certain trade-offs. For a full quantitative analysis, you could refer to this report.
Source of Data: Charts are from ProThinker Stock Report. Company description, historical financial statements data and price data are from gurufocus.com. Estimates are from gurufocus and/or 4-traders.com – Thomson Reuters.
Disclaimer: This report is for information purposes only and should not be considered a solicitation to buy or sell any security. Neither ProThinker nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without the express written consent of ProThinker. Copyright(c) 2018. All rights reserved.