High dividend payout driving rally in IT stocks

Since FY15, top 5 IT firms’ share price has risen 116% against 132% increase in cash-pay out

India’s top IT companies have been among the top performers on the bourses in recent years. The share prices of the country’s top five IT companies have risen at a compound annual growth rate (CAGR) of 13.7 per cent in the last six years, ahead of the benchmark BSE Sensex, which rose at a CAGR of 10 per cent during the period.

The combined market capitalisation of the big five – Tata Consultancy Services, Infosys, Wipro, HCL Tech, and Tech Mahindra – is up nearly 87 per cent since March 2020, much higher than the 68 per cent rally in the Sensex. They account for nearly 90 per cent of the combined market capitalisation of the listed IT firms in India.

A close scrutiny of their numbers suggests that their

share price and market capitalisation have been more sensitive to dividend payout and share buybacks rather than earnings growth.

In the last six years, the dividend payout and share buybacks by these firms has grown at a CAGR of 15.1 per cent, against about 13.7 per cent annualised rise in companies’ share price. In contrast, their combined net profit grew at a CAGR of 7.4 per cent. Last fiscal, their net profits were up 6.2 per cent while cash payout was up by 18 per cent year-on-year.

In FY15, the industry distributed nearly 60 per cent of its net profit as dividend, nearly twice the payout ratio of the previous five years. The ratio dipped in the next two years, but in the last four years, the industry has paid nearly 85 per cent of its net profits as dividend and share buyback to their shareholders. The payout ratio in FY21 was around 89 per cent.

Another option is to use their cash pile to make acquisitions to grow inorganically and follow the footsteps of Accenture, their Usbased rival.

The big five were sitting on record cash and equivalent worth around ~1.36 trillion at the end of March this year, up nearly 20 per cent from ~1.13 trillion a year ago. The free cash on the books was equivalent to nearly 45 per cent of their net worth at the end of FY21.

Slow growth in earnings, however, means that IT companies may have to dip in their cash reserves to maintain double-digit growth in annual payouts. This lowers future dividends potential and could weigh on industry valuation and share price. The top five IT companies are currently trading at price to earnings multiple of nearly 30X on average, the highest in 15 years.