FPI flows send IT stocks and valuations soaring this year, shows data

Analysts bullish over near-to-medium term

Information technology (IT) has emerged as the most preferred bet for foreign portfolio investors (FPIs) this year. Their allocation to the sector this year went up 129 basis points to 14.67 per cent until the end of August. They, on the other hand, have drastically pruned exposure to banking and financial stocks, a traditional favourite. Until August 31, the allocation to the sector had declined by 305 basis points to 31.8 per cent, shows the data compiled by IIFL Alternative Research.
 
The higher allocation sent stocks and valuations soaring in the IT sector, with the NSE IT index gaining 45 per cent this year, so far. In comparison, the Sensex is up 22 per cent YTD.
 
“The strong upward price action in Indian technology in the past couple of months has baffled even the diehard bulls. Stocks are trading at significantly higher multiples. In some cases, higher than five-year mean plus-3 standard deviation,” note Manik Taneja and KG Vishnu, analysts at JM Financial.
 
The key drivers underpinning bullish sentiment are increased spends on IT after the Covid pandemic and stable margins.
 
“We continue to believe that the sector is heading into a phase seen through 2004-07 when it enjoyed both volume and pricing leverage with companies being able to defend/manage margins despite the supply side constraints, led by growth leverage. We reckon the Q2FY22 earnings season to provide further confidence on sustained revenue growth over the near/medium term,” the two analysts add.
 
The Street expects the IT sector to post earnings growth of 20 per cent YoY in FY22 and 18 per cent in FY23.
 
Foreign brokerage Jefferies, which recently conducted an Indian IT summit, says the growth outlook remains positive. This can help meet growth estimates.
 

“Overall demand commentary was positive with all companies expecting accelerated growth over the next three-five years. Deal pipelines remain near all-time highs led by mid-sized deals. Megadeals are more likely in 2022/23. Most companies expect supply pressures to continue over the next two-three quarters driving volatility in margins,” it said.
 
In a note last week, Philip Capital listed six reasons for being “fundamentally positive” on the IT sector. These include growth in global market share, positive outlook by Gartner, strong deal pipeline, pricing power, opportunity in the European market, and easing of supply side pressure.
 
“We believe there are six fundamental reasons to the core of the massive rerating the sector has seen over the past year. We also believe all these factors are sustainable and will continue to drive strong earnings growth for the sector over the near-to-medium term,” the brokerage says.