CORPORATE FINANCE

FINAL ASSIGNMENT

THE INFOSYS WAY

DATE: 15/10/2011

SUBMITTED TO: PROF. DILIP THOSAR

SUBMITTED BY: DHRUV PATEL 61250 VIRAL DESAI 61566 FSB-2

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DECLARATION

We, the undersigned, hereby declare that the documentary Project Report entitled The Infosys way written and submitted by us to Prof. Dilip thosar, in partial fulfillment of the requirement of the course; Corporate finance, is our original work and the conclusions drawn therein are based on the material collected by ourselves.

Place: Pune Date: 22/9/2011

Signature DHRUV PATEL VIRAL DESAI

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ACKNOWLEDGEMENT

It is our proud privilege to express our sincere gratitude to all those who helped us directly or indirectly in completion of this project report. We are very thankful to FLAME for providing all the facilities to complete our project. We, gratefully acknowledge the valuable guidance and support of Prof. Dilip Thosar; our faculty for Corporate finance & our project guide, who had been of immense help to us in choosing the topic and successful completion of the project. We extend our sincere thanks to all those who have either directly or indirectly helped us for the completion of this project. An endeavor has been made to make the project error free yet we apologize for the mistakes.

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EXECUTIVE SUMMARY

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CONTENTS

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OBJECTIVE

To evaluate the company fundamentally as well as technically and provide a reason to invest in Infosys. But the next question that arises is why IT sector? and then why Infosys? Poised to become a US$ 225 billion industry by 2020, the Indian information technology (IT) industry has played a key role in putting India on the global map. The IT-BPO sector has become one of the most significant growth catalysts for the Indian economy. In addition to fuelling Indias economy, this industry is also positively influencing the lives of its people through an active direct and indirect contribution to various socio-economic parameters such as employment, standard of living and diversity. The industry has played a significant role in transforming Indias image from a slow moving bureaucratic economy to a land of innovative entrepreneurs and a global player in providing world class technology solutions and business services, according to National Association of Software and Service Companies (NASSCOM). The sector is estimated to have grown by 19 per cent in the FY2011, clocking revenue of almost US$ 76 billion. Indias outsourcing industry has witnessed a rebound and registered better than expected growth according to NASSCOM. The export revenues are estimated to have aggregated to US$ 59 billion in FY2011 and contributed 26 per cent as its share in total Indian exports (merchandise plus services), according to a research report IT-BPO Sector in India: Strategic Review 2011, published by NASSCOM. The workforce in Indian IT industry will touch 30 million by 2020 and this sunrise industry is expected to continue its mammoth growth, expect various industry experts. Furthermore, NASSCOM said that the domestic IT-BPO revenues excluding hardware are expected to have grown at almost 16 per cent to reach US$ 17.35 billion in FY2011. Strong economic growth, rapid advancement in technology infrastructure, increasingly competitive Indian organizations, enhanced focus by the government and emergence of business models that help provide IT to new

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customer segments are the key drivers for increased technology adoption in India. The data centre services market in the country is forecast to grow at a compound annual growth rate (CAGR) of 22.7 per cent between 2009 and 2011, to touch close to US$ 2.2 billion by the end of 2011, according to research firm IDC India's report. The IDC India report stated that the overall India data centre services market in 2009 was estimated at US$ 1.39 billion. India will see its number of internet users triple to 237 million by 2015, from 81 million registered in September 2010, according to a report titled 'Internet's New bn', by the Boston Consulting Group (BCG). BCG said Internet penetration rate in India is expected to reach 19 per cent by 2015, up from the current seven per cent. Telecom Regulatory Authority of India (TRAI) is targeting a 10-fold increase in broadband subscribers to 100 million by 2014. The country has 10.29 million subscribers now. "We will have 100 million broadband subscribers by 2014," J.S. Sarma, Chairman, TRAI said at the fifth India Digital Summit 2010 organized by the Internet and Mobile Association of India. The penetration of the internet in rural areas will see an all time high in 2011. In a survey conducted by IMRB for the Internet and Mobile Association of India (IAMAI), the total number of active internet users in rural area will rise by 98 per cent to touch 24 million by the end of 2011 from 12.1 million in December 2010. The survey said that the claimed internet user category is also set to grow by 96 per cent to reach 29.9 million by December 2011 from 15.2 million in December 2010. (Active users are those, who have used the internet at least once in the past one month. Claimed internet users are those, who have used the internet sometime but not necessarily in the past one month.) The Growth Story India is a preferred destination for companies looking to offshore their IT and backoffice functions. It also retains its low-cost advantage and is a financially attractive

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location when viewed in combination with the business environment it offers and the availability of skilled people. The countrys domestic market for business process outsourcing (BPO) is projected to grow over 23 per cent to touch US$ 1.4 billion in 2011, says global research group Gartner. In 2010, the domestic BPO market was worth US$ 1.1 billion. The firm predicts that the domestic BPO market would reach US$ 1.69 billion in 2012 and increase to US$ 2.47 billion by 2014. India's top technology firms like TCS, Infosys, Wipro and HCL are readying plans to gain a bigger share of their largest market, US, by aggressively chasing contracts being served by multinational rivals. Analysts expect the top IT firms to grow between 23-27 per cent in the FY2012 on the back of more number of discretionary projects, improved pricing, and robust business volumes.

METHODOLGY

All shares needs to be evaluated before being purchased. There are champions available in this world who masters this art of share analysis. We common people can only aspire and try to reach to that effectiveness. Take example of likes of Warren Buffett and Peter Lynch who has almost perfected the art of share valuation. But the question we all want to ask that, we common people, who are not experts of stock market, what we can do to buy shares like masters. In this report we will try to list down some key points which prospective investors can use for their investmentadvantage. General Observations The fist visible think that investors will be exposed about a share is its market price. In isolation, market price of a share speaks nothing about its value. As an intelligent investor, one must to get more meaning out of the market price of a share. We must now how the market price of share has behaved in last one year (52 weeks). Try asking this question, whether the current price is towards 52W high or 52W low? If it market 8|Page

price is towards 52W high it means there is price appreciation. It is possible that due to this price appreciation the share may be already over-valued. So this needs to be analyzed that whether the share is overvalued or still it has opportunity for some appreciation. The objective is to establish a trend (a pattern) of market price of share. Once you get an idea of the trend of market price of share (rising, falling) your next step is to compare the market price with the book value per share. If the market price is less than the book value it is a first visible sign that this share may be undervalued. Ideally speaking if share is equal to or less than its book value then it gives a small hint towards profitable investment. But of course we need to see other parameters as well. As a rule of thumb a share whose price to book value ratio is above 1.5 may be hinting towards overvaluation. Price Earnings Ratio (P/E) is another readily visible indicator that is very helpful in share evaluation. But again P/E ratio in isolation (like market price of share) will speak a lot about share valuation. But if you will compare the P/E ratio of this company with average P/E of all companies of its sector, you will get an idea that whether this share is trading at undervalued rates or overvalued rates. Another visible indicator (but the most powerful) that talks a lot about the performance and psychology of company is its dividend yield. If a companies dividend yield is higher than current risk free rate (presently it is approx 7.0% to 7.5%) then it automatically becomes a favored stock. But you will hardly find shares with such high dividend yield. If at all you find those will be only one time payments. So it is important to check that if a company has paid high dividend then whether they have been paying it consistently over a period of time or it is one-off case. Balance Sheet A lot of information is contained in the Balance sheet of the company related to the financial health of a company. If we call a person as wealthy, then it is obvious that this wealth has not come to him in a short time. After years and years of wealth accumulation and persons becomes rich now. The same is applicable for a company/organization. The wealth accumulated by a company over a period of time is reflected in its balance sheet. In financial terms the accumulated wealth of a company 9|Page

is called as net worth. It is equal to accumulated reserves plus shareholders equity. Generally the share holders equity remains constant for a period of time (it not varying frequently). But the reserves of a company should ideally increase year after year. From the profit made by the company, a portion of it is transferred to the companies balance sheet as reserves. This happens every year. The faster the company reserves are growing (means net worth) the stronger the company gets financially. A company which is paying good dividends and simultaneously increasing its reserves very fast provides ideal investment opportunity for investors. Cash & Bank Balance positions of companies are also reflected in Balance sheet of a company as current assets. For a company to run its day-to-day operations they need sufficient liquid cash to pay all their immediate dues (called as current liability). If cash and bank balance positions are showing positive values over a period of time (say last 5 years) it means that the company has been managing its cash flow well It is also important to note how companies fixed assets (Net Block) has increased over a period of time. In order to make a meaning of the net block figures, we will have to compare it the sales turnover (available in income statements) of the company (sales/net block). The Net block (fixed assets) of the company should ideally increase year after year. This means that the company is expanding its capacity. With capacity expansion the sales volume will also grow. With increasing sales/net block over a period of time, it means that the company is effectively using its fixed assets to produce more goods and services. Similarly like net block (fixed assets), we must also track variation in sales/inventory ratio over a period of time. Ideally this ratio should be increasing. We have already noted the book value of the company in our general observations. But it is also important to see how the book value has increase over a period of say 5 years. Book value has direct effect on the market price of share. Generally all good shares maintain a constant price/book value ratio. So with increase of book value the market price will also rise. If book value is increasing fast, it means you have a chance of fast market price appreciation. But some companies, issue additional shares for want of fund. In this case the book value per share gets reduced and this in turn will

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affect the market price of share (it will be reduced in same proportion in a course of time). Profit and loss accounts Like Balance sheet tells us about the accumulated wealth of the company, Profit and loss accounts tells us about only last years performance (income, expenses & profits) of a company. The first thing that is worth noting in the income statement is the rate of increase of sales volume & operating profit of the company over a period of say last 5 years. Note the annual growth rate (CAGR) of sales and operating profit over a period of 5 years. A healthy growth in sales and operating profit is a good sign that the company is capturing wider market and also its is increasing its capacity to match the increased demand. Bettering its operating profit means that the manufacturing process if becoming more efficient. The second thing which is important worth noting in income statements is number of shares outstanding in the market. Ideally the number of shares issued for public trading shall be constant. But often companies issues additional shares for more fund generation to do business. But increase of number of outstanding shares also reduces three important share characteristics which directly affects the market value of share. (1) Book Value per share, (2) Earning per share & (3) Dividend payment per share. In short term issuing additional shares decreases the intrinsic value of share. For existing investors, increase in number of outstanding shares is never good (at least in short term). The most important value of income statement is Earnings per share (EPS). Yes it is not suggested to see the net profit after taxes (PAT) instead see the EPS figures. Even if companys PAT is increasing but if company has issued new shares then EPS will come down. This has direct negative impact not only on the market valuation of share 11 | P a g e

but also on dividend income. So if a shares EPS is only growing it is better. Note down the CAGR of EPS. The faster the EPS is growing the faster the market price and dividend disbursement will increase. Dividend payment (total value) made to the shareholders are also appearing in the financial statements of a company. An investor must note down the percentage of dividend paid as compared to the net profit figures. Suppose a company has a policy of dividend disbursement policy of say 30% of reported net profit, so if EPS is growing at 10% per year then dividend payment will also increase in the same proportion (10% p.a.). Cash Flow Statements Not many investors use cash flow statements to evaluate shares value. But cash flow statement gives immense realization about short term health of the company. The first thing that is evident in cash flow statements is called Net increase/decrease in cash and cash equivalents. Observe this value for a period of last five years. Ideally speaking this must always be positive. A company which has enough short term liquidity to pay all its current liabilities are the companies which can sustain its position in the market. Negative cash flow for few years in succession (or lack of liquid cash availability) will eventually force the company to shut-down. It may be possible that the company is making good profits but if they are not able to maintain continuous positive cash flow (not collecting money fast) then it will not be able to run its day to day operations. Ultimately lack of positive cash will affect its sales. As investors you must know that whether the company is buying or selling its own shares. This will be known to you if you see Net cash increase/decrease from financing activity. If this value is negative then it means that the company is buying its own shares. A company will buy its own shares only when they think that in times to come (say 5 years) its value is going to appreciate drastically. It is also worth noting the Net cash increase/decrease from investing activities. We have seen in our balance sheet a parameter called cash and bank balance. A company should never have a negative bank balance and neither shall have too high cash sitting idle in bank. So what company does in either to invest in other companies 12 | P a g e

shares, or do some acquisitions. So if net cash in investing activity is showing negative it means that the company is investing. This is a good sign, provided the net cash is not negative. In times of crisis (to manage cash flow) companies operations cannot generate enough cash to manage the expenses. In this case company sell their investments (it will appear as positive cash flow in investing activity) to generate enough funds. This shows that companies operations are not as profitable. Other possibility is also there, that the company has sold their holdings in one of the nonprofitable companies. In this case the overall profitability of the company will rise. The shares that we buy must be valuable from objective of investment. The value of shares can be justified by fundamental analysis. In fundamental analysis we analyze the financial health of a company. The financial health of a company is mainly driven by three business parameters:

(1) (2) (3)

Sales Profit Dividends paid to shareholders

On basis of these three fundamental business-parameters, the share analysis is done. It is important to understand that why we need to do fundamental analysis of shares before buying or selling. Fundamental analysis will give you an idea that how much money the share of a company will make for you in long term. Basically we all buy shares to protect and make our capital grow. Dividends are the real-time income that investors make in short term. Fundamental analysis of share will answer to questions: (1) If the share we are buying are overvalued & (2) What level of money (in form of dividends earning) we are going to make by purchasing a share. Actually both the parameters (1) & (2) are deeply interlinked. If the shares that we buy are undervalued then it will surely make healthy dividends. But in order to know this we must do fundamental analysis of shares. In order to make the fundamental analysis effective, one must learn to read financial statements of companies like Balance Sheets, Profit and Loss accounts & Cash Flow 13 | P a g e

Statements. For new investors, it is always a great idea to start share market investment through fundamental analysis route. There are other share analysis methods for sure, but fundamental analysis will also allow you to learn the business process as well. Profits & losses

Companies Profits Profits are important for a company. It is these profits that enable shareholders to earn from profit sharing in the form of dividends. Also market price of shares is also very much dependent of profits of a company. As an investors who is interested to fundamental analysis of shares shall always start to look at companies profit making potentials. By referring to income statement of last five years, try to see how the companies profits have behaved in the past. A company which has always made positive income and its income has only gown hints at a financially healthy company. It is a suggestion to prospective new investors that do not always get attracted by large values of earnings. Important is to look at the profitability and consistency of growth of earnings. Even smaller companies (which have lower earnings compared to giants) can be very profitable and hence has ability to pay healthy dividends. It is a different thing that as a philosophy not all companies pay high dividends. Earning Per Shares

For an investor the value which is more important than profit is called Earning per Share (EPS). Even if the company is making healthy profits each year but simultaneously they are also incessantly issuing new share, means EPS gets reduced. By increasing the number of shares outstanding in the market, there will be more shareholders to share your profit. Suppose a company makes $1Mn as profit and number of shares outstanding in the market is 0.1 Million. Means EPS = 10. If number of shares outstanding increases from 0.1 million to 0.2 million then EPS will be reduced from 10 to 5. Reducing EPS directly means lower value of dividends in your hand. 14 | P a g e

Price Earnings Ratio

A company which has growing EPS year after year may still be unprofitable for investors. In case you will buy shares of companies at overvalued rates then your dividend yield (or possibility of price appreciation) also drastically reduces. But you can use the value of EPS to approximately gaze if the share is overvalued or undervalued. Take an average of last five years EPS of a company. Suppose the value of average EPS you get it is 8. On the same time suppose the market price of that share is Rs 100. So P/E ratio will be = 100/8 = 12.5. As a rule of thumb any P/E ratio less than 15 it can be considered as a good buy. But do not just buy shares by this rule, also it will be good to compare the PE ratio of the company in consideration with its competitors. Higher value of P/E ratio means that the price of share is overvalued. Price Earning Growth Ratio (PEG Ratio)

There are some companies that you will find that the P/E ratio is always high (much above 15). But you will see that still investors (trained) are buying that share. There is a justification for this non-standard practice. A company whose EPS is growing at a very fast rate will justify its high P/E ratio. Suppose a company has a P/E ratio of 20 and its growth of EPS is last five years is also 20% per annum. Then the ratio of PR ratio Vs. EPS growth (which is PEG ratio) will be 20/20=1. It the PEG ratio is one or less than 1 then it means that the high P/E ratio is justified. Dividend-profit sharing

Dividend Consistency

It is important for the investors to invest in a company that shares its profits with 15 | P a g e

utmost consistency. For the sake of fundamental analysis it is very much advisable to look at the dividend payouts each year by the company. It will be better to invest in a company that pays consistently lower dividends than a company that pays erratic/non consistent higher dividends. Dividend Yield

Once you have crossed the level of consistent dividends you should then start analyzing the shares profitability for you. The true value of a share is the value of money it can make for you in a year. Suppose you bought a share worth $100 which earns you a consistent dividend of $7.6 per year. It means that the dividend yield of that share is 7.6%. Suppose at this moment of time risk free interest rate is 6% per annum. If the dividend yield is more than risk free interest rate then we can say that the share is profitable and undervalued. But important is to analyze the fundamentals of the company to pay consistent dividends in tome to come. Return on Equity (ROE)

To understand if the company is capable of paying good dividends in future, you must use the tool called return on equity (ROE). Lets take a small example, suppose two companies (A & B) make equal profit of $10 per share. You as investors should select in which company? Of course we will select a company that has better dividend yield. But it is also important to if the same level of profit will be made by company in times to come. To understand this we shall have a look into the book value of the company. Idea is to know that how much asset is generating this $10/share. Suppose Company A has book value of $100/share and B has $150/share. It means ROE for A is 10% and for B is 6.6%. This exercise tells us that A is more profitable than B. Hence the possibility that company will continue to pay the same level of dividends is much higher than B. Price to Book Value Ratio

There is another way to understand if the company is healthy enough to pay high 16 | P a g e

dividends in times to come is by using Price to book value ratio. Ideally if a quality company has price to book value ratio (P/B) of less than 1.5 is ideal. Above 1.5 indicates that the share may be overvalued. Sales volume

Valuing market price compared to sales volume

To find if the companys shares is getting undervalued or overvalued can be understood by using this tool. Calculate sale/ share ratio for the past five years. Also note the market price of share (at the end of financial year) for each of the past five years. Now calculate Price/Sales ratio for each of the year. If the value of Price/Sales ratio is decreasing, it means that the growth in sales is faster than market price appreciation. This is a positive indicator for investors.

Conclusion As a new investor, it is very important to see all indicators both technical and fundamental in order to arrive to a decision that a particular share is worth buying or not. You will get small-small hints by referring to balance sheet, income statements and cash flow statements. These small hints in total will give you a good feeling about the fundamental health of a company. A company which is fundamentally healthy and is available at undervalued price levels are worth buying.

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ANALYSIS

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Inf osys is not a new name in the stock market. It is the second largest exporter of IT services in India. This company has a big name in the global market as-well. Infosys, along with the Indian IT industry has seen a quick turnaround in growth over the last six -nine months. The value of rupee is slipping down and companies like Inf osys are getting prof it.It is positive for the whole IT space indeed and at this point of time market is also not moving anywhere. Infosys has proven to be a stable friend even though in tough times and has the tendency to recover at a f aster pace than the stock markets. The company has seen a major jump in conso lidated income up to rupees 21693 crores which is 29.96% over the previous year.Net profit has grown to rupees 6828 crores from rupees 4941 crores a jump of 38%. The company continues to grow with operational profit of operating 34.08%. Cost of capital providing good signals Infys decision to look at a minimum return of twice the cost of capital on average capital employed and thrice the cost of capital on average invested capital has given new way to challenges. The current cost of capital for Infosys is 12.18%. It has come down from 13.32% last year as it has factored in 7% as return on risk free capital as opposed to 8% last year for computing cost of capital. Policy of dividend: a mojor attraction for conservative investors Infosys is maintaining a dividend pay-out ratio of 30% of net profits and it has been listed down as a strategy last year. Shares of the company rose post the revenue guidance provided by IT bell whether. Cash on balance sheet a solid back-bone: Companys cash and cash equivalents have increased to nearly rupees 10,000 crores which are invested in fixed deposits. Infosys has always maintained that they would not be keen in looking at aggressive acquisitions to grow. It would invariably be niche acquisitions to fill skillset or geographical gaps The company is focusing on emerging markets like India, China, Mexico, Brazil, Middle East, Australia and Japan. Company CEO,Kris Gopalakrishnan said that 63 per cent of Infosys business is centred in North America, 23 per cent in Europe and 14 per cent in the rest of the world. Its share price has gone to more than 3000 in current year.

Current investment plan at Infosys: Infosys is to invest in many big areas this year. It is planning to invest around 120 crore rupees in Mahindra World City, Chennai. The company had said exports from this centre rose by 43 per cent. It is also looking at investing around $100 million in

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its Chinese operations over a period of time and would strengthen the employee count there to 4,000.

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