Ideal opportunity in IT stocks

Valuations good; currency volatility not a big worry

Investors in information technology (IT) companies would be a worried lot. With all the leading companies in the sector announcing disappointing numbers, their stock prices are down sharply. The newly-constituted BSE Information Technology Index went from its all time-high of 11,537.82, on April 16 to its all-time low of 10,326.31 within a span of 15 days.

But analysts believe that good times aren’t over because results of the just-ended quarter should not be taken as a trend. The consensus: this is a good time to invest, given the current low valuations and the fact that currency fluctuation is not as big a threat as earlier.

Currently, the price-to-earnings ratio of the BSE Information Technology Index is at 19.68x. In comparison, the PE ratio of the Sensex at 19.98x. Generally, IT stocks command a multiple of three to the broader index, say analysts. So, the sector is fairly valued currently.

Nishchal Maheshwari, executive vice-president, Edelweiss Securities, says in the last quarter losses were on account of cross currency movement, but that will not be the case going ahead as the euro is expected to appreciate against the US dollar. Besides, there will be strong demand for IT services, so margins will be strong for all IT companies.

“If you hold IT stocks, remain invested for the next two to three years. You can even buy fresh stocks at these levels since valuations look good now,” he says.

Aviral Gupta, founder and fund manager, Mynte Advisors, also agrees that he will be a buyer in IT stocks at these levels. IT companies lost business on account of the weakness in sectors like BSFI, telecom and energy. But investors should take comfort from the fact that the deal pipelines of IT firms are strong.

Globally, since outsourcing of IT services by companies is increasing, profits of Indian IT firms will continue to be stable, even if they dip slightly. But given that valuations have come down, it is a good time to invest in the sector, says Sarabjit Nangra, vice-president-research, Angel Broking. “Profits may see a marginal dip. But over one year we expect most IT stocks to give 25-30 per cent returns,” she says.

The bad results of the fourth quarter should not be seen as a trend, as it has come on the back of a very good quarter, points out Feroze Azeez, executive director, Anand Rathi Private Wealth Management. “If you are looking to exit a sector, you should do so only if the results have been bad for four successive quarters. But that is not the case with IT. Going ahead, the IT sector will do very well for the next two to three years,” he says.

However, among IT companies, those that offer product innovation will do well, as they will be able to generate a premium for their services. This is unlike the situation three to four years back, when there was high demand for companies that offered plain vanilla services like maintenance. “Now investors must choose those IT companies that are known for product innovation,” points out Azeez.

Investors must also check the order book to see if the company's clients are large firms or smaller firms. This is because, globally, larger firms spend more on IT. So, a company whose revenues come from a smaller number of large clients is a better option than a company whose revenues come from a bigger number of smaller clients, Azeez adds.