More downside in large cap IT stocks, but mid and small cap counterparts hold promise, says Envision's Nilesh Shah

Nilesh Shah, Managing Director and CEO of Envision Capital.

Large-cap IT stocks are facing continued selling pressure, largely driven by limited growth potential in the face of global uncertainties and downside risks looming in the backyard, according to Nilesh Shah, Managing Director and CEO of Envision Capital. Speaking to CNBC-TV18, Shah cautioned against the sluggish growth rates in the sector and the valuation constraints, which according to him can trigger more downside in large-cap IT counters.

“In the very short term, large-cap IT stocks remain correlated with the NASDAQ and US markets. However, the real challenge they face is tepid growth, which has been an issue for several years now,” Shah stated. “With US GDP growing at around 2-3 percent, these companies are managing only 4-5 percent growth in dollar terms, and at best, high single-digit growth in rupee terms.”

He further pointed out that large IT firms are trading at 23-24 times trailing earnings, with a valuation floor at 20 times and a ceiling at 30 times. This suggests that there could still be some downside left for investors in these stocks. Instead, Shah feels that the real opportunity lies within the tier-two and tier-three IT firms, particularly those focusing on developing their own AI solutions.

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“The companies that invest in their own generative AI solutions will be the big winners over the medium to long term,” he said, adding that some tier-two IT firms have already corrected by 30-40 percent over the past two months, making their valuations more attractive.

Small and mid-caps IT players still hold potential

Shah remains optimistic about mid and small-cap stocks, highlighting their faster growth compared to large-cap peers. “These companies are becoming more capital-efficient, have better access to markets, and are strong in their niches. They have a strong growth trajectory ahead,” he explained.

While large-cap stocks in IT sector are grappling with stagnant growth, smaller firms continue to gain market share and operate in high-growth segments. Shah believes mid and small-cap stocks offer better risk-reward ratios over the long term, as large-cap stocks might yield only high single-digit returns, similar to fixed-income investments.

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