Infosys is one of India’s great companies.

It’s conservative in every sense of the word. They would rather err on the side of caution than adventure near the sidelines. They’re financially conservative. They follow all laws in letter and spirit of all the countries they operate in. They are conservative in which company and how they acquire. Most CEOs take modest pays and live a modest life. Conservatism is in the DNA of the company. How do I know all this? Because I can proudly say that I worked there for 13 years. (If there is one flaw, I would say they love to talk to the media a little too much.)

Infosys is also one of India’s great success stories. Early shareholders, if they held onto their shares may have seen returns north of 100 X during the Y2K and dotcom bubble. Infosys was an example of a great company and a great investment.

But Infosys has struggled this decade. Not with sales. Not with profits. Both Sales and Profits grew at a compounded rate of 14% and 13% respectively between 2011 and 2018. These are exceptional figures for a company that big.

The Company clocked a Return on Equity (ROE) at a clip rate between 24% to 27% for most part of that time without employing any debt. (ROE is a proxy for how efficiently a company is investing the shareholder’s money.)

Infosys’ has a boatload of money which actually pulled the ROE down. If you could take out all the cash (If, if, if…), you will find the operating business to be super efficient returning between 40 to 75%.

Lets talk about the boatload of money called Cash and Investments for a minute. What are these? A company like Infosys generates so much cash that it keeps aside some portion of it for future needs or acquisitions. These are parked in mutual funds and fixed deposits. Here is how much the cash earned for Infosys — 9 to 11%. Compare that to what the core business of Infosys earned- 40 to 75%!

At this point, do you even remember that I mentioned that they struggled? With what? With capital allocation. They were generating tons of free cash but they didn’t know what to do with their money.

Let me explain. Every company has really only 5 uses of the capital:

1. Use it in its own operations for say buying new machinery or constructing more offices etc.
2. Use it to pay down debt.
3. Use it to acquire other companies.
4. Pay dividends to shareholders.
5. Buyback shares from shareholders.

Lets see what Infosys did. Also, lets break up the time period into two- FY 2012–14 and FY 2015–2018 to see the contrast

Between 2012 and 2014:

• 27% of CFO was reinvested in itself probably new buildings, equipment etc.
• 43% of CFO was paid out as dividends.
• 5% was spent on Acquisitions.

Net: only 75% of the cash generated was utilized. 25% just got added to the cash reserve. In fact by 2014, Infosys had nearly 29,000 Crs sitting idle! That is 29,000,00,00,000 Rs.

Between 2015 and 2018:

• 23% was reinvested.
• 5% was spent on Acquisitions.
• 61% was paid out as dividends.
• 30% was used in the Buyback.

Net: Infosys spent nearly 120% of what it earned and a majority of it was given back to shareholders in the form of dividends and buybacks. In FY12–14, Infosys gave back 12,000 Crs to shareholders. In FY 2015–18, they gave back 39,000 Crs! What a change in capital allocation!

So how did the Market react to Infosys’ capital allocation?

Assume you invested Rs 100,000 in Apr 2011. What would your returns be like?

Let me explain:

1. As you may recall, Infosys pays out a majority of its earnings as dividends. Therefore an investor is likely to see a lot of dividends and less of capital gains.
2. The business model of Infosys is such that it generates a ton of free cash (that is money after paying all employees, suppliers, taxes etc.). Their main problem however is what to do with all the free cash.
3. Infosys is conservative with respect to acquisitions as well. I respect them for that. Hence they spent only 5% between 2011–14 and 5% between 2014–18.
4. Between 2011–14, if there were no opportunities to acquire or use the money for capital expenditures, they should’ve returned the money to the shareholders in the form of bigger dividends and buybacks. After all, that excess money earned only 10%. Imagine 25,000 Crs earning just 10%! If they had given back a major portion of that money to shareholders, they could’ve invested in more promising opportunities.
5. The new management team in 2014–18, seemed to have realized that they didn’t have better opportunities to invest or acquire either. And so they increased dividend payouts and executed a buyback returning 39,000 Crs to shareholders in that period, compared to 12,000 Crs in 2011–14 period.
6. As a result, between 2011–14, the returns to a shareholder was about 10%p.a., including dividends and capital gains. (That is assuming you bought on 1 Apr 2011 and exited on 31 Mar 2014).
7. And between 2014–18, the returns were 18.8% p.a. including dividends and capital gains. (That is assuming you bought on 1 Apr 2014 and exited on 31 Mar 2018).
8. Even the Market seems to have noticed the better capital allocation. Between 2011–14, the Market appreciated the share price only by about 4.8% p.a.. And between 2014–18, it was 7.5% p.a. Like, I said, if you are an Infosys investor, you are likely to see more dividends and less capital gains over long periods of time.
9. Accounting treats R&D expenses, advertising expenses, training related salaries as expenses and not investments. While in business terms, these are investments because they would give you better results in future. These don’t show up under capex. So I am using capex as a proxy for the investment. Sorry.

So let me summarize this long post:

1. Capital allocation matters. If the management of any company is unable to find ways to reinvest money at high rates, either through internal projects or acquisitions, they should return that money to shareholders. This is the longest I have written without quoting Warren or Charlie. So here is a Buffett quote from the 1984 letter: “Unrestricted earnings should be retained only when there is a reasonable prospect — backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future — that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.”
2. Nothing can grow forever. It’s just the nature of business that companies can’t keep growing at very high rates forever; it’s just not possible. Once companies mature and enter the slow growth zone, they can’t go into denial and hope that the golden times of high growth will come back. They have to acknowledge reality and if they are unable to invest and grow, they should return the money to shareholders.
3. Over long stretches of time, Market rewards good capital allocation and punishes bad allocation. (FY 2012–14 vs FY 2015–18)
4. While I am being mildly critical of the management, I am also appreciative of the fact that they didn’t do mindless acquisitions or get into unrelated businesses. Coca Cola, for example, invested in movie studios because they didn’t know what to do with all the money. So, I am glad, Infosys didn’t do anything like this.
5. Sometimes a great company can be a great investment and sometimes the two are different. (Infosys in the 90s vs Infosys in 2011–18).

My apologies to anyone that may have been even mildly offended by my post. As such, I know very little about anything, so please don’t take anything I say seriously.