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3 software company metrics to follow this earnings season
Profits and sales are important for companies. However, as an investor, it is important to go beyond these while picking and analysing stocks. Simply analysing growth in profits and sales is not enough. After all, growth need not always be sustainable.
And that’s where financial and profitability metrics come into play. These help you understand if a company is inherently profitable. This could help it sustain in the years to come.
Here are 3 important metrics to add to your arsenal this quarter to analyse IT stocks:
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Billing Rates:
Software companies do not sell goods; they offer services. These projects often run for months together. Companies usually charge for these services on a per-employee, per-hour basis. This is called the Billing rate. For IT companies, employees are the biggest asset. However, the profit-making ability is hard to gauge. This is why analysts look at the billing rate. It reflects how much revenue the average employee earns for the company. It thus helps measure the IT business’ profitability. In the last few years, billing rates have fallen as companies provided discounts during the period of poor economic growth.
Billing rates are different from average realisations, which are influenced by the mix of services, verticals and geographies where they are provided. Moreover, with more automation setting in, the realisations per employee are going up even if billing rates are stable or falling. This differentiation needs to be kept in mind.
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Digital Revenues:
Digital comprises of services in SMAC – Social media, Mobile, Analytics and Cloud. These are the emerging themes and clients globally are spending billions of dollars on these initiatives. Several brick-and-mortar companies are shifting on-line, mobile-enabling their operations, etc. Companies which have developed capabilities early in these services will tend to benefit. This is an important metric to track. For eg. TCS has 15.5% of revenues coming from Digital.
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Off-shore / On-site Revenues
It’s largely known that the Indian IT sector has clients in the US and European markets. The Indian IT market forms a very small part of the revenues of IT companies. However, services provided from India to global customers is a very large part of revenues. These services provided to clients in US / Europe / etc from India are called off-shore services. They differ from on-site service, which are provided to the client from the client’s location. Off-shore services come at a higher margin because employee costs in India are much lower than those in on-site locations. Thus, more and more companies try to bring work off-shore.
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0.2-0.5%
The rupee depreciated 2.4% against the US dollar in the quarter ended March 2016. This is ideally supposed to benefit IT companies, since they earn in dollars. However, the rupee appreciated 3.4% against the British pound. UK happens to be the second largest market for Indian IT service provides after the US. To measure the impact of these forex fluctuations, analysts follow a metric called ‘Cross Currency Impact’. This takes into consideration the change in rupee value against different currencies and the company’s revenue from that market. As per this metric, IT companies could see a 0.2-0.5% fall in rupee revenues in the March quarter, according to a Kotak Securities report.
