After strong underperformance last year, IT stocks slowly started returning to focus, thanks to in-line quarterly earnings, lower valuations and easing worries over rate hikes and a recession.
This year so far, the Nifty IT index is up about 7 percent against a nearly 3 percent fall in the benchmark Nifty50. Stocks such as Persistent Systems have jumped 25 percent while shares of Coforge and HCL Tech have gained 14 percent and 11 percent, respectively.
Why are IT stocks rising?
Most negatives for the IT sector, such as the risk of a recession in the West, are already on the table now. The December quarter earnings have offered clarity on the demand scenario for them which is not significantly negative. Falling attrition and subdued wage growth are also positives for the sector.
Hopes have grown stronger that the rate hikes will pause gradually and the global economy will come out of the grip of slowdown. All this seems to have made IT stocks attractive for the long term when their valuations have come down after the correction. Most large IT stocks are trading at a discount over the last one year.
Deepak Jasani, Head of Retail Research, HDFC Securities underscored that the IT index rose in January as the Q3 results and guidance by management were either in line or better than expectations though the outlook of revenue visibility in terms of large orders is still uncertain.
"The sector also saw some defensive buying as a lot of other sectors underperformed (either due to Q3 results or other macro reasons). The Street feels the sector may outperform if the markets continue declining," said Jasani.
Raj Vyas, Portfolio Manager, Teji Mandi observed pointed out that most of the IT companies are showing signs of falling attrition rates this quarter, and with the current layoff season going on in the tech sector, the attrition rates for the IT majors may come down in the next couple of quarters.
"Due to falling attrition and good earnings performance, we are witnessing the IT sector index in positive territory over the last one month, indicating that buying in the sector has already begun," said Vyas.
Time to buy?
The current trends in the IT sector may look upbeat but it is too early to claim that all is well for the sector. Analysts recommend waiting for more clarity on how inflation, rate hikes and trends of a recession evolve in the coming few months.
"The Nifty IT Index along with the IT stocks, appear to be rangebound, on the back of negative news flows of downsizing across major global tech companies and slowdown in the global economy. Investors, those who had bought the recent lows, ideally should look at booking profits as long-term charts of most IT stocks and the IT Index currently display a consolidation pattern," said Aamar Deo Singh, Head Advisory, Angel One.
However, investors with long-term investment horizons can pick some largecap players from the IT pack because the fresh trends in the sector are expected to augur well in the long run.
Vyas of Teji Mandi said, "Considering the broader picture in place, IT stocks still remain favourable for a longer period of time."
He highlighted that the biggest takeaway from the recent Q3FY23 Earnings especially the IT major pack is that things are steady as of now. Despite the macro uncertainties, and fear of higher furloughs, execution has been good and the revenue growth has been steady.
Margins have expanded on a sequential basis on account of the rupee depreciation, and improvement in utilisation aided by fresher hiring that boosted the margin performance.
He also pointed out that despite some slowdown in decision-making, overall the deal wins in the December quarter have been steady and were not as bad as expected.
Vyas added that Europe business is a bit challenging as the management is witnessing slower decision-making, but there has been no deal cancellation.
Attrition was a big overhang for almost every IT company and it has now begun to moderate. The management has indicated that the peak of the attrition rate is now a story of the past.
Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.