Investors push Indian IT majors' stock valuations to reach decade high

Top 5 are trading at 24.9x their trailing 12-mth net profit

As equity investors scramble for investment candidates in an environment of poor growth and benign liquidity, cash-rich IT services exporters — Tata Consultancy Services, Infosys, Wipro, HCL Technologies, and Tech Mahindra — are the new favourites of investors. Investors new-found love for India’s technology majors had pushed their valuations to the highest level in nearly a decade. 

India’s top five technology companies are currently trading at 24.9x their trailing 12-month net profit on average, the highest since the March 2011 quarter when these companies were trading at 25.2x their trailing earnings. 

These companies had a combined market capitalisation of Rs 18.4 trillion as of Wednesday, against their combined net profit of around Rs 73,740 crore in the four quarters ended June 30 this year. 

The price-to-earnings (P/E) multiple of the top five IT stocks had fallen to a 10-quarter low of 16.8x at the end of March this year.  

India’s tech majors, however, are still trading at nearly 25 per cent discount to the broader market. The benchmark Nifty50 index is currently trading at nearly 33x its underlying trailing 12 months, close to the all-time high. 

In fact, tech stocks are the only ones to have given positive returns during September, even as the broader market saw a correction. The top five tech stocks have rallied nearly 11 per cent on average in September, against a 1.2 per cent decline in the Nifty50 index. 

Among individual companies, TCS is the most expensive with P/E multiple of nearly 30x, followed by Infosys with a P/E of 25.2x. Wipro is the least expensive among the big five with P/E multiple of 18.3x. 

The past six months have been the best for IT stocks in 11 years. The combined market capitalisation of the top-five IT companies is up 48 per cent since March this year – their best showing in a six-month period since March-September 2009 when their combined market capitalisation went 115 per cent up.

Analysts say the current rally in IT stocks is being driven by lack of growth opportunities in other sectors, such as banking and consumer, rather than faster earnings growth in the IT sector. The combined net profit of IT companies was up 3.3 per cent year-on-year during the four quarters ended June 30, while their net sales were up 6.9 per cent. Both numbers were at the lowest in the past two years.

“Their pace of growth has slowed down but the IT sector still has earnings visibility, unlike most other sectors which face the prospect of earnings contraction due to Covid-19. The market is willing to give premium to even modest growth as long as it better than the overall corporate universe,” says Dhananjay Sinha, head research Systematix Institutional Equity.

According to Sinha, the valuation re-rating of Indian IT companies is in line with the global rally in technology stocks in the past six months.

IT companies combined net profit was flat in the June 20 quarter, against a 26 per cent decline in the combined earnings of Nifty50 companies in the quarter on a year-on-year basis. Many analysts now expect IT companies to report faster top-line and bottom-line growth in forthcoming quarters because of the work-from-home scenario and social distancing. “The pandemic opened new digital opportunities for IT companies as more business activities have moved online. This has built up an expectation among investors that IT companies will report much faster earnings growth in the next few quarters,” says G Chokkalingam, founder & MD, Equinomics Research & Advisory Services.