Before you read further, let me give you an insight from my family. There are people who “know” (like my father) – and they are mostly proved wrong. Then they are people who “know not” (like my mother) – and she is mostly lucky. And then there are people who “think they know” (like me) – and they mostly make an ass of themselves.
All of us know what PE means. Its the amount of dollars investors are ready to pay for each dollar of earning. For most of us it’s really simple. Low PE for a company that we know has prospects, makes it a good buy and vice-versa. To judge what’s low, we compare it to PE of the industry or to companies in the same business. Bada-bing Bada-boom .. done. And then we see these.
Huh? I like Google, Larry Page is God etc. but I am no Moses. I am not confident that the Red Sea is going to part for me. Google doing 4 times (23.65 * 4 = 94.6) better than Microsoft sounds audacious. And lets not even talk about these third world companies trading at a P/E 2 to 3 times of Microsoft. What gives? Aha, but I am forgetting what I preached before i.e. stick to what you know. I am not utilizing my knowledge of the software industry. These might be in the same business as far as my mother is concerned. But, I a software engineer/ programmer/ hacker/ developer (excuse the bit of an identity crisis here)  should know better.
Infosys and Cognizant are software services providers, while Microsoft is in the business of developing operating systems and Google is all things internet. Maybe this is an apples to oranges comparison. We are still stuck though. Infosys and Cognizant are very similar. Microsoft and Google, though still different are rapidly approaching each other . So if we were to stick with P/E’s buying MSFT is no brainer. Why aren’t the investors being rational? Why are they flocking to all these other companies? You might say “Investors – rational is an oxymoron and it’s called market sentiment you idiot.”
Maybe so, but lets give it one more shot. How about growth potential? Let’s look at the PEG Ratio which is (P/E ratio) / Annual EPS Growth Rate (It’s in %). You look at PEG the same way look at P/E the lower the PEG the better value for money. Actully PEG is not scientific its just a rule of thumb. The popular interpretation being, if its 1 the stock is fairly priced, less than 1 its cheap, and more than 1 its expensive.
|Symbol||P/E||Annual EPS Growth Rate||PEG|
The EPS Growth rate are over a 5yr period, values taken from TD Waterhouse. I pulled Google’s growth rate out of thin air (the basis being 633% growth in the last quarter) since it does not have a 5yr history.
Now that gives an entirely different picture. Doesn’t it? It makes MSFT look freaking expensive and Google damn cheap. Didn’t somebody say you can prove anything with statistics. Healthy circumspection aside, I do think that CTSH and INFY are good buys. They have shown very high growth rates for about 5yrs and even if they slow down I don’t expect them to slow down by a lot. I would keep away from Google. It may have grown by 633% last quarter, but the party is not going to last for long.
What about our rule of thumb? PEG’s for all of these are still above or close to 1. Let’s flip the argument and assume a PEG of 1 for each of these i.e. we assume all of these are fairly priced. That implies the market is expecting 95% growth from GOOG, 24% growth from MSFT, 80% growth from INFY and 49% growth from CTSH. Which of these expectations are more likely to come true? Look at the growth rate in the past 5 yrs, your gut feeling about the prospects of these companies and you will know what to do. Sell all your stocks and buy CD’s (i.e. if you are rational).
Lastly, what about fluctuations in dollar values. Yes, these can definitely have an impact on valuations of foreign companies like INFY and CTSH. But, its slightly more complicated. A stronger dollar normally cuts into returns from foreign companies . In this case though – these companies (INFY and CTSH) get most of their revenues in dollars – a stronger dollar is going to boost their bottom line thus have a positive effect.
 My friends employed in large public companies can’t help pitying me. I went from a “Core Programmer” at Elixar to a “Computer Programmer” at nsoftware. And yes the job title definitely reflects my skills and job duties – I was programming the “CORE” at Elixar and I am programming the “COMPUTER” at nsoftware. Scared – you should be. I will say this much for the MBA’s in the software industry, they might suck at everything IT, but they sure can come up with sexy job titles – Systems Analyst, Solutions Architect ….