AI fears rattle domestic IT stocks, is the risk fully priced in?

Nifty IT valuations cool

• Indian IT stocks fell sharply amid AI automation concerns and deal win risks
• AI tools may slow client spending and impact IT firms' revenue growth
• Analysts advise caution; selective buying in quality IT stocks recommended

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Domestic IT players have seen a sharp moderation in their share prices and valuations after the Anthropic-led meltdown seen in the previous session. As Indian technology companies failed to cash in on the AI-led rally across the globe, further concerns around AI-driven automation tools are posing challenges to the traditional IT services model.

However, even though the moderation in IT players’ shares may seem more sentiment-driven, the rising usage and implementation of AI tools could slow down client spending, impacting deal wins and topline growth. Therefore, experts suggest that there could be further pain ahead for the segment, and investors should avoid bottom-fishing.

Which IT players are likely to be most affected by AI?

On February 3, Anthropic released a plug-in that helps automate daily tasks through its Claude Cowork tool, along with 11 plug-ins released on January 30. These plug-ins help automate everyday tasks while holding domain-specific expertise across key business functions. This update caused a stir among investors, who rushed to offload their holdings in IT services players, BPO companies, and other firms that could see their workflows automated.

Further, AI giant Palantir announced its AIP (Artificial Intelligence Platform), which reduces the timeline for complex cloud migration of SAP (ERP software) to a few weeks from a few years earlier. International brokerage Jefferies noted that AI is clearly compressing migration timelines, which in turn may drag application implementation revenues for IT services firms.

According to Jefferies, AI is going to be a drag on revenue growth for IT firms over the next 1–2 years, as the deflation in revenues from existing service lines, such as application services, will more than offset emerging revenue streams from AI adoption. “This will keep revenue growth under pressure.”

Before Palantir’s comments on ERP, Motilal Oswal estimated that 30-40 percent of IT services revenues are at risk from AI deflation, largely focused on app development, maintenance, and testing. Assuming a 30-50 percent productivity hit on low-level work in these areas, the brokerage believes that 9-12 percent of IT services revenue stands to be eliminated.

“We expect this to happen over 3-4 years, underscoring a ~2 percent hit on revenue growth each year. If ERP migration and third-party enterprise software (10-15 percent of industry revenues) come under the purview of AI, the hit from AI would be higher,” the brokerage added.

Among large IT firms, TCS, Tech Mahindra, and LTIMindtree have higher exposure to application services (55-60 percent), while HCLTech (40 percent) has the lowest exposure. Within ERP services, Wipro and LTIMindtree have the highest exposure (20 percent of sales), while Tech Mahindra has the lowest exposure at 12 percent.

Valuations tumble: should you buy?

The fear of AI-driven tools has impacted the share price of the Nifty IT index, which has corrected 16 percent over the past year, with most of the losses coming over the past week following the index’s 6.5 percent fall. Among the key laggards over the past year, large-caps TCS and Wipro have led the losses, while Infosys and Tech Mahindra have fallen over 7 percent each over the past week.

As a result of the fall in share prices and earnings misses, the valuation of the sector has also come down. The Nifty IT index is trading at 22x, close to its 10-year average valuation, and also near its 10-year average premium to the Nifty.

Individual stocks have also seen a moderation in their P/E ratios. Coforge, Infosys, TCS, and OFSS have seen the sharpest tapering of valuation metrics. However, this fall does not mean it is time to go bottom-fishing, cautioned analysts.

Jefferies said that consensus growth estimates do not fully reflect the AI threat. As a result, there are sharp downside risks to valuations. The international brokerage suggested that investors remain selective. In the large-cap space, Jefferies prefers HCL Technologies and Infosys, while its picks among small- and mid-cap IT players are Coforge and Sagility.

Given the sharp sell-off driven by AI-related fears rather than company-specific weaknesses, long-term investors may selectively accumulate high-quality IT names with strong client stickiness and solid balance sheets, said Antu Eapen Thomas, Research Analyst at Geojit Investments. “However, investors should keep an eye on trends in deal wins in the coming quarters.”

“This is incrementally negative for the sector. Over the next 3–6 months, we will continue to monitor AI-native partnerships, which will be a key driver over the next 12–14 months. We expect this to lead to a pick-up in AI services deals by mid-2026 in the form of short-cycle deals. We are seeing an acceleration in AI partnerships and hence maintain our view on the sector for now.”

Sameer Pardikar, Vice President at Elara Capital, suggested that investors remain cautious until earnings visibility improves. While more selling is not expected, Pardikar said he would not recommend buying at these levels either.

On the flip side, international brokerage Macquarie was more optimistic about the future of the domestic IT sector. According to the brokerage, AI impact concerns are overdone and there is no significant revenue disruption risk. Indian IT services firms typically cater to large enterprise customers with multi-country operations that have extremely complex SAP environments, which AI cannot replicate.

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