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Home / Industry / Infotech /  $350 bn wiped from the valuation of IT stocks in 2022

Crash bang wallop!

The BSE IT Index is down 27% compared to a 6% fall in the BSE Sensex between 1 January and 19 July.

Investors are antsy on fears of an impending recession in the US leading to a broad sell-off in the stocks of technology services firms. The argument is that rising inflation and borrowing rates would lead people to spend less, which will in turn force businesses to relook at their expenses, including technology spending, eventually translating to less demand for services from the likes of Tata Consultancy Services Ltd and Infosys Ltd.

Agreed, none of the companies, until now, have flagged any concerns. TCS and HCL Technologies Ltd (the two companies to have declared their first-quarter earnings) remain buoyant. But both companies saw their profitability plummet to their lowest level, hurt by rising salary bills for their employees.

IT services firms have done well over the last few years. BSE IT index returned 56% last year and 57% in 2020 as against a 22% and 15.8% jump at the Sensex during the same time. The five largest homegrown companies, including TCS, Infosys, HCL, Wipro Ltd and Tech Mahindra Ltd, grew at the fastest pace last year in almost a decade.

Market wisdom dictates that greed wins over rational behaviour in a rally. But conversely, Twich+ would like to argue that fear calls the shorts at the first whiff of trouble.

This paranoia probably explains the current carnage witnessed in the IT sector. If each of the 20 IT stocks is measured from their all-time high in 2022, about $347 billion has been wiped from the valuation as of 19 July, according to a Twich+ analysis.

IT services firms' market cap erosion.
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IT services firms' market cap erosion.
Market cap of foreign IT services companies
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Market cap of foreign IT services companies

So, will the tide change in the second half of the year?

Your writer is not competent to weigh on the stock market gyrations. Let us first hear what the IT services companies and analysts have to say.

On Tuesday, Wipro chairman Rishad Premji reiterated the sanguine commentary for the sector. “The technology services industry, at some level, is recession-proof," Premji said at Wipro’s Annual General Meeting. “In good times, clients spend on new initiatives and business transformation and serving customers digitally. They focus on reducing costs when times are not so good," said Premji.

Premji’s views echo what TCS’s chief executive Rajesh Gopinathan has maintained for a few years. TCS maintains that its technology solutions are essential to companies across industries, helping its clients from Citigroup Inc. to Walmart Inc. to do their business more efficiently. Even before TCS first came up with this narrative, Abhiram Eleswarapu, Head of Equities at BNP Paribas Securities India, coined this trend as technology staples in 2016.

Not all are convinced as few investors continue to stay away from investing in the technology services sector.

One of them is Solidarity Advisors Pvt Ltd, a Mumbai-based investment management firm that invests in listed stocks.

“Our hesitation to participate is because we believe that bottom line growth will be more in the range of 10-12% over a decade as IT Services companies will face margin challenges from large deals which tend to be margin dilutive, wage inflation driven by talent shortages in digital, the need to invest more in on-site customer-facing roles and as cost benefits from the covid-19 are either priced away or return (e.g. travel costs)," Solidarity’s founder and chief investment officer, Manish Gupta wrote in a letter to its partners on 5 July last year.

Gupta, who earlier worked with Rakesh Jhunjhunwala, estimates that the largest IT services companies can manage to grow their profit in the mid-teens over the next five years, and this does not make it an attractive investment space.

“If we assume 15% earnings CAGR over 5 years for leading IT players (aggressive in our view) and 20% multiple declines on mean reversion, we estimate an overall IRR of ~12% including dividends. While that is not a poor return, we want to conserve capital for better IRR opportunities."

Solidarity claims its rate of return since it started in May 2016, is a healthy 18.4% a year compared to 12% for Nifty.

Finally, Twich+ would argue that the performance of IT stocks will also depend on how the Indian economy fares. The five IT stocks, including TCS, Infosys, HCL Technologies, Wipro and Tech Mahindra, constitute a fifth of the Sensex 30 index’s weightage.

Investors could turn to the technology sector if the banks or consumer goods are plagued by a slowdown. This happened in the second half of the calendar year 2020.

Bottom line: The second half of the year promises to be a rollercoaster ride for investors in IT stocks.

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