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Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity—Howard Marks

Well, global and Indian markets have been yo-yoing nowadays and finding it difficult to break themselves free from the chilling clutches of the bears. But until recently, stock selection seemed like a popularity contest.  And technology was the most popular theme, by far.

A few weeks ago, we wrote a story on India’s gen-Z-driven rising tally of demat accounts and highlighted how new investors should position their portfolios for uncertain times. (You can read the entire article here).

This week we thought of doing a quick review of the technology sector—a blue-eyed boy of gen-Z investors.

As you might be aware, the popular tune of digitization helped new-age platform companies and even more conventional IT companies enjoy the limelight for the past two years. But now that the lights are off and the camera has stopped rolling, for the time being at least, investing in beaten down IT stocks is no great shakes.

Several IT industry experts and stock market mavens believe that the rising employee costs may hit the profit margins of tech companies.

Some of India’s leading IT companies have witnessed a 50% jump in their employee headcounts between FY19 and FY22. Companies went on a hiring spree chiefly in FY22 to capitalize on a decadal growth opportunity.

Have you seen some of them welcoming graduates from any stream for their walk-ins? Such has been the demand for white-collar talent. As a result, their salary costs shot up in the financial year gone by.

This is a view captured from 15,000 feet above ground—read in the media and heard from business channels. Now let’s look at bare data which reveals the true story.

Given an enviable improvement in the revenue and profits of IT companies, it would be slightly unintelligent to look at their employee costs in isolation. We must compare their pre-pandemic and post pandemic average salaries. Similarly, salary costs as a percentage of their revenue would be a better indicator of pressure on their profit margins.

Growing average salary and falling employee cost as a percentage of revenue is the sweet spot. After all, happy employees make great contributions. Let’s see how many companies have managed to attain that.

Average salary and employee cost stats of Indian IT companies

Here’s the most crucial observation

There hasn’t been much difference in the average salary of IT companies for the past 5-6 years, if you adjust them for inflation. Because any claim that says the cost of talent is going up has to be validated on an inflation-adjusted basis.

Meanwhile, their revenues have gone up by anywhere between 40% and 100% in absolute terms. In fact in some cases, the average salary has dipped. This goes to show that a buck earned isn’t percolating with the same gravity from the top to bottom. And this seems to be the biggest cause of attrition, which is at an all-time high, for most of the IT companies operating in India.

To tackle this issue, IT companies have adopted a two-pronged approach. They are doling out fat incentives to retain talent and investing in up-skilling.  Some of them have decided to hire more talent from smaller towns as the attrition rate seems to lower there as compared to that in the top 4-5 cities.

Companies have selectively reworked their employee contract clauses to make it difficult for their employees to leave. For instance, employees of Infosys can’t accept offers from its competitors for as many as six months after leaving the company.

Recently, Nascent IT Employees Senate (NITES) knocked on the doors of the labour ministry seeking relief against the allegedly high-handed attitude of the Bengaluru-headquartered IT giant. The labour ministry has directed the company to submit its written response by May 16.

Let’s slice data differently. If only the top-grade employees were leaving, then attrition rates wouldn’t have been as high as 25% in some cases. It means the Indian IT industry isn’t an exception to the wave of great resignations as employees decide to realign their career path to adjust to the post-pandemic situation.

If the rising wage bill is really to be blamed for the mounting pressure on profit margins then wouldn’t it be prudent to add one more ratio to quarterly declarations? Management compensation to employee costs?

And rising employee costs should also consider the jump in the headcount in FY21 and FY22. To be able to take up new projects and ensure effective execution of contracts already inked, companies need to have adequate human resources all the time.

In all practical sense, employees sitting on the bench also contribute passively because they allow the sales team to take up fresh projects.

By the way, what do the rising wage bill, as a percentage of revenue, the falling average salary and the rising headcount denote? Are companies hiring cheap (and also incompetent?) resources at the bottom of the pyramid and signing fat cheques to retain talent at the top?

Now when you see the current meltdown in IT stocks on this backdrop do you think valuations could be the real trouble? Profit-booking by Foreign Portfolio Investors (FPIs) might be another factor—which is not just limited to Indian markets.

At worst, if IT companies don’t manage to grow their revenue and expand their deal pipeline in future only then rising employee costs may put them in a tight spot. Until then, rising wage bills might just remain an excuse for profit-booking.

Buying from a distress seller and selling to a distress buyer is a surefire success recipe in markets but very few actually manage to do so when the time comes.

Under the prevailing market condition what do you plan to do? Give them the cold shoulder since they are still way above their 2-year lows or buy IT stocks now and on declines?

You may also like to read: Jindal SAW: seamless company fractured performance?

 

 

Disclaimer:

The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.

We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances. Asset allocation becomes extremely relevant.

 

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company.

We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

 

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