Personal Finance: Surfing The Software Minefield

PERSONAL FINANCE: TECH STOCKS
Surfing The Software Minefield

Accepted, software is a four-letter word right now for investors. Still, if you're careful, you can pick up tomorrow's winners among software companies for a song.

By Shilpa Nayak

The season's four-letter word for the investor-community is tech. And among tech stocks, the lowest of all life forms, going by investor perception, is the software scrip. Listen to the buzz on the streets, and you're certain to come across adjective-laden descriptions of what people would like to do to software stocks. If, gentle reader, you surmise from the mutterings that things aren't well in the software-domain (at least as far as the stock market is concerned), you surmise right. Still, the list of safe software stocks doesn't start with HCL Technologies and end with Wipro, with just one other stock, Infosys, between. These it services-oldies should still constitute the bulk of your software-portfolio, but if you refuse to look beyond them you are shutting the door on wealth-creation opportunities. Imagine picking the next Infosys at Rs 14.

You could choose a worse time to do this: most software stocks are quoting 80 per cent to 90 per cent off their prime. That should bring them into the investment radius of even the most conservative investors. Affordability is no indication of quality, but there's enough evidence to suggest that some mid-sized software companies aren't as bad as their current market prices make them out to be. These are companies that have been around for some time and scaled their operations up to a respectable level. Surely, there's no reason why their price-earnings multiple should fall from over 50 to less than 10? Not when they're continuing to grow at 100 per cent! Not convinced? Fine, let us assume, then, that there exists a strong rationale (three very strong reasons actually) not to invest in mid-cap software stocks. And by establishing a case to the contrary let us compile a list of software stocks that are indeed great buys today.

Reason # I: Lousy Management

The senior management lacks vision,'' mouth market messiahs . That's certainly true of me-too software firms that have mushroomed; it isn't, of a few mid-sized technocrat-managed software companies like VisualSoft Technologies, Polaris Software, SSI, and Aftek Infosys. Technocrat-managers understand technology, and are probably better equipped to interpret the altering technological topography.

''The transition from a small company to a large one isn't easy. The management has to have a vision to move up the value chain,'' says Nilesh Shah, Chief Investment Officer, Templeton. Take a look at a company called SSI. Not too long ago, it was in the software education business. Then, the company's management decided to move into the lucrative software services market. Eighteen months and three acquisitions later, the company's client-roster includes the likes of Intel and AT&T. The education business ensures steady cash flows; and the software services business, hyper-growth.

Reason # II: Too Much Of A Niche

The minute analysts identify the market segment being targeted by a company as a niche, caveats about the perils of being a niche-player follow. It's risky they say. The niche could dry up any time, they posit. Both could happen (and the sky could fall on your head too). Fact is, some mid-sized companies can match their larger cousins in their chosen area of specialisation. VisualSoft, for instance, is focusing its energies on creating off-the-shelf software components that can be used by developers. The product-emphasis helps growth in margins (up from 48 per cent for the quarter ended September 30 compared to 43 per cent in the corresponding period last year). Another mid-sized software company, Polaris Software, has identified the banking and financial services sector as its preferred target market (the segment accounts for 25 per cent of all it spending). And still another company, Aftek Infosys, has a small but significant product line-up including several smartcard readers and PowerSafe, a ups monitoring software. The born-again Ramco Systems is another good bet. The company has developed a framework called Ramco Virtual Works that'll allow customers to cut the cost and time involved in software applications. ''Given its expected consolidated profits of $50 million in 2001-2, the current market cap of $170 million makes it a big steal,'' says Kenneth Andrade, Portfolio Advisor, Sharekhan.

Reason # III: Anaemic Financials

Here's another chestnut: financial strength, or rather the lack of it, will prevent some of these companies from scaling up. Seven years ago, Infosys' net profit was a mere Rs 5 crore. That didn't choke the company's growth. Accepted, some software companies are showing signs of fatigue. Look closer, though, and you'll realise that it's the small-cap companies that're reporting flat growths in sales and profits. Indeed, a sample of 20-odd small cap software companies reported a 16 per cent growth in sales and a 10 per cent growth in profits for the quarter ended September 30. The corresponding figures for a sample of 10 mid-cap companies were 17 per cent and 33 per cent. Indeed, the better mid-cap software companies will face no problems in sustaining growth in their sales and profits. That apart, the market is certain to wake up and re-rate the stock upwards. And to flip that argument on its head, even if the market de-rates the entire software sector, mid-cap stocks, which any way do not boast high PE Multiples, will not lose much.

Having proved that the three oft-quoted reasons to shun mid-cap software stocks are absurd, we can go ahead and conclude that there is indeed a strong logic to invest in them. The only caveat: the stock should remain liquid (or tradable). Agrees Mahesh Vaze, a software analyst at Motilal oswal Securities: ''Funds now stay away from such companies where volumes flare up only when the markets move up and dry out when the markets are down.'' Volumes do not really matter to a retail investor, but it is a comfortable feeling to know that there is always a way out.

Issue Contents Write to us Subscriptions Syndication