The information technology (IT) segment is considered a defensive sector, as Indian investors tend to take refuge in these stocks when the market hits a rough patch. But a defensive position in the sector has not played out well during the current selloff.
The IT sector has been among the biggest losers this calendar year. The Nifty IT is down more than 20 percent, so far, against a 17 percent slide in the benchmark indices during the period.
The IT index constituents are down up to 35 percent in 2022, with some falling about half from their 52-week high levels.
Whether it is India’s biggest IT player TCS or midcap L&T Tech, no stock has been spared from the brutal selloff in the sector. This comes at a time when the rupee has been depreciating against the US dollar, which is considered a positive for India’s export-oriented IT sector.
Not so fast
Given the selloff, should you be buying these stocks? Analysts are not, too, sure. They believe IT stocks will continue to be underperformer for a while.
“The best for IT sector may be over on a short to medium-term basis because valuations continue to be on the upper side compared to the long-term trend,” said Vinod Nair, Head of Research at Geojit Financial Services.
The correction, he added, could be an opportunity for long-term investors, especially for top picks in IT and online services.
Top IT stocks—TCS, Infosys, Tech Mahindra, HCL Tech, and Wipro—are trading in the range of price to earnings ratio of 20-30 times.
Midcap IT stocks like Mphasis, L&T Tech Services are trading at relatively higher valuation.
A majority of the IT stocks are trading near their five-year average valuation and the market is expected to be conservative during the year, offering an opportunity to invest in defensives and not get affected by inflation and a rising interest cycle.
Plenty of headwinds
Another reason for underperformance in the sector has been the high foreign investor stake in these companies. Foreign investors have been extremely bearish, withdrawing tens of thousands of crores every month from the Indian market for the last eight months, with IT and banking sectors bearing the brunt of the outflow.
Vinit Bolinjkar, Head of Research, Ventura Securities, highlighted how during 2020-21 Indian IT companies witnessed significant order flow from the global corporates and went on a hiring spree to capitalise on a decadal growth opportunity.
“However, with the easing of pandemic-led restrictions, order flow growth started sliding and it may not increase in line with the employee cost of the company,” said Bolinjkar. “Such a situation is expected to create a mismatch between revenue and employee cost growth, which may impact the profitability of IT companies in FY23 and FY24.”
Analysts also point to worries about a possible recession in the US worsening the outlook for IT stocks. IT companies generate most of their revenues from the North American region. Any slowdown there will have a direct impact on Indian players.
“Ongoing global macro-economic uncertainty and decade-high inflation could result in US Federal Reserve raising interest rates more aggressively, which could possibly trigger a recession in the US economy in the next 12 months. The Nifty IT index is expected to underperform in 2022,” Akhilesh Jat, Category Manager - Equity Research, CapitalVia Global Research.Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.