IT sector as a contra bet: Is this the right time to invest or should you stay away?

The earnings for the IT majors in the June quarter of the financial year 2023-24 (Q1FY24) have remained subdued, however, experts see recovery in this space in the next few quarters driven by sustained margins and strong order books. Further, the recent underperformance of the sector makes it an attractive investment opportunity in the long term.

Like all major indices, the Nifty IT index also hit its 52-week high of 31,658 earlier this month on July 17, however, it has not touched its record high levels till now this year.

The index is still almost 25 percent away from its all-time high of 39,447, hit in January 2022, whereas benchmark indices Nifty and Sensex and most of the sectoral indices have already hit new peaks this month.

The sector gave exceptional returns right after the COVID pandemic ended, however, after hitting its record high, it has been on a continuous downtrend on concerns regarding US recession, weak margins, slow order book and poor growth prospects. This year, meanwhile, has seen some recovery on the back of improvement in the aforementioned concerns.

Nifty IT has advanced just over 5 percent in the last 1 year as against an over 18 percent jump in benchmark Nifty. Meanwhile, in 2023 YTD, the IT index gained 4 percent while the benchmark Nifty added over 9 percent.

However, it has been giving positive returns for 3 consecutive months now since May, up over 7 percent in this time after 3 straight months of negative returns between Feb and April.

Constituents

In 2023 YTD, all Nifty IT constituents, except Infosys (down 11.2 percent), have given positive returns. Persistent Systems has surged the most, 21 percent, followed by Coforge, 20.8 percent. Meanwhile, Mphasis, Tech Mahindra, and LTIMindTree have also given double-digit returns, rising between 11 and 15 percent. L&T Tech and HCL Tech also advanced over 7 percent each whereas TCS and Wipro added 4.5 percent and 2.5 percent, respectively, this year.

Should investors buy IT stocks as a contra bet in the current market environment?

To answer this, let's first understand what is a contra bet. These are stocks that are not in flavour or popular in the market currently due to short-term reasons but are good long-term bets and available at a very reasonable value. Like in this case, the IT index has been on a downward trend since the beginning of last year due to multiple near-term headwinds but experts still deem it as a good long-term investment. So should you buy IT stocks now? Let's see what experts have to say:

Nirvi Ashar - Fundamental Analyst, Religare Broking

We believe investors should start buying and accumulating IT stocks as there is a limited scope of the downside and available at a reasonable valuation i.e. near its 10-year average P/E multiple. Also, the next phase of growth is expected to be driven by a recovery in demand, client spending, and focus on product development with newer technology including automation, AI, cyber security, etc. which are in high demand. Amongst the pack, we would suggest investors to invest in large-cap IT names such as TCS, HCL Tech and Infosys.

Vinod TP, Research analyst at Geojit Financial Services

Despite muted Q1 numbers, Indian IT companies are expected to rebound in the next couple of quarters with sustained margins and a growing order book size. The sector's valuation has dropped significantly by over one-third, making it an attractive long-term investment option. Major growth drivers such as cloud, digitalization, generative AI, and cybersecurity further enhance its revenue potential. We recommend TCS & LTIM among large caps, and Cyient in smallcaps.

Mohit Jain, Research Analyst, Anand Rathi Institutional Equities

It is no longer a contra bet as was the case in Dec/Jan timeframe. At current prices and the environment, one needs to be more selective. Companies although remained cautious on near-term outlook, sounded confident on the long-term growth story. The strong deal wins/ pipeline was a clear indication of the same. Some of this is built into the prices. Apart from LTIM, our other top picks are Persistent Systems, Firstsource Solutions, and Mastek.

Siddhesh Mehta, Research Analyst, SAMCO Securities

The IT sector has shown resilience and adaptability during challenging times, making it an attractive option for contrarian investors looking for opportunities. Currently, the prices of major IT companies such as TCS, Infosys, and HCL Technologies have declined by 13 percent, 23 percent, and 14 percent respectively, from their peak levels in 2021, indicating potential undervaluation. Investors can add these key IT giants to their portfolios to take advantage of the potential upside in the IT sector.

Suman Bannerjee, CIO, Hedonova

The rupee is weak and this means higher revenues for IT companies for the next two quarters at least. I feel investing in IT stocks as a contra bet in the current market environment could be a prudent strategy. Despite the market fluctuations, the IT sector has shown resilience and growth potential. My top picks would be TCS, Saksoft and Wipro.

Technical View

Anand James, Chief Market Strategist at Geojit Financial Services

The Nifty IT index is very close to its nearest peak, and so is TCS. Since TCS constitutes a little above 25 percent of the IT index. Both their price patterns since 2020 not being dissimilar, there is the question of potential bullish exhaustion creeping in, given the steep rise in a short period. However, the IT index is coming off a long period of underperformance and is still almost 20 percent below the record peak, even though many other sectoral as well as benchmark indices have tested new peaks. This encourages us to remain optimistic about the index and is positive about seeing new leaders emerging. One such stock is Wipro which is traditionally a slow mover on charts but has now broken above the neckline of a classic inverted H&S pattern, setting up a move till at least 470-480, within 3 months, that would retrace 50 percent of the fall since March. Stop loss may be placed three percent below the neckline, which is at 410.