India IT Services:: Consensus is a perverse predictor of stock price movements - it rarely gets the turn of the cycle right :JPMorgan

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 Should investors heed consensus at this juncture? How reliable is
consensus as a leading indicator during turns of the business cycle? One
argument that investors often put forward in our discussions with them is that
further falls in the stock prices of Indian IT companies are likely with consensus
downgrades. As per Bloomberg, consensus still has Tier-1 Indian IT growing
top-line at ~18-20% in FY13 and as long as this is not revised downwards,
stocks will continue to see downside. How tenable is this argument?
 Consensus is rarely a predictor of the turn of the business cycle (either
downturns or upturns). It plays catch-up and often in perverse fashion. A
good example of this was seen in the 2008 financial crisis, where stocks reacted
much earlier than consensus. Consensus nos. duly started getting revised
downwards only 4-5 months after the Lehman collapse (Sep 08) but by then
perversely, IT stocks started rising. Also, in contrary fashion, consensus, after
falling to account for the Lehman downturn, started to rise to reflect the start of
the earnings upturn post Lehman, almost a good 2-3 quarters after stocks started
rising. We have seen this with perfect 100% correlation in all four Tier-1 Indian
IT stocks (TCS, Infosys, Wipro and HCLT) in the previous crisis.
 Our self-explanatory, comprehensive charts showing price action versus
consensus earnings movement covering 3 recent “turn-of-cycle” phases in
the industry provide conclusive support to our contention. For each of the
four front-line Indian IT companies, we cover the three critical “turn of cycle”
periods: (a) start of the downturn around the time of the Lehman failure, (b) the
start of the earnings upturn starting mid-CY09, (c) the most recent period
(starting June 2011) marking the start of potentially the second downturn.
 Implications for investors today as we stare at another potential downturn.
Seeing consensus numbers coming down may not be a signal to SELL but to
BUY. Price action will already have substantially occurred, before consensus
downgrades. As an example, consensus still has Infosys’ US$ FY12 revenue
growth pegged at 20% (in accordance with Infosys’ FY12 revenue growth
guidance), but is Infosys’ stock price of Rs2,275 already telling us something
else? If Infosys meets its revenue guidance, implying that stiffer back-ended
growth expectations in 2H FY12 are met, the Infosys stock will likely rally.
 Also, Infosys’ consensus FY13 EPS is Rs 160 (versus our estimate of Rs 150) -
yet we believe that the Infosys stock could return at least 15-20% if our EPS
nos. (6% below consensus) are met (we assume that the specific visa-related
lawsuit against the company is settled so that it becomes less of a hangover for
Infosys and the sector). In sum, we think Indian IT stocks today at the start of
the second down-cycle are already pricing in disappointments that consensus has
not yet built in (to the extent of 5-6% downward revisions). What is important is
not to see what consensus is pricing in, but to reckon the potential earnings miss
already in the price which consensus fails to recognize at the turn of the cycle.
 We estimate tier-1 stocks in our universe could still return 15-20% over 6-9
mths given valuations of median less one standard deviation for all except
TCS. On a risk-adjusted basis, we still prefer TCS (OW) for its proven ability to
notch up market share gains, holding margins. HCLT (OW) is also a good pick
provided it holds its EBIT margins through not just FY12 but FY13 as well.