10 May IT stocks: Down up to 50% from peak, Should you Buy now or wait?

Is it time to take a contra bet on IT?

The IT sector has been experiencing a significant decline, with Nifty IT dropping almost 12% from its one-year peak, while the benchmark Nifty is only 3% below its all-time high.

Despite this, many investors are considering a contrarian approach to IT stocks.

The economic slowdown in key markets is one of the primary reasons for the decline in IT stocks.

However, it is challenging to ignore the potential of IT stocks, which are likely to gain in the long run as economic recovery becomes visible and profitability increases.

While IT stocks are likely to recover in the long run, the question remains –

Is now the right time to invest, or should one wait for more correction?

Also Read: Why This Fundamentally Strong EV Stock is on a Bullish Run in a Bear Market?

Why are IT stocks under pressure?

The IT sector has been facing a downturn due to the worsening economic conditions in key global markets such as the US and Europe.

The risk of a recession in the US and unstable financial markets in the West have further compounded the pressure on the sector.

Boom and Bust of the IT sector

The IT sector witnessed a boom during the pandemic in 2020 and 2021, as demand for IT products and IT-enabled services surged.

However, this growth was short-lived as global central banks started tightening their monetary policies, which impacted the economy that was yet to fully recover from the Covid-19 effect.

Demand deterioration in North America

The IT sector began to feel the heat of demand deterioration from North America, with clients pausing, delaying, and even canceling discretionary programs.

Additionally, higher attrition and tough competition made it even more challenging for IT firms to flex margin levers.

Subpar earnings in Q1

The earnings of IT firms for the January-March quarter of 2023 have been below average, contributing to the decline in IT stocks.

Despite the long-term potential of the sector, the current economic conditions and market sentiment suggest a cautious approach to investing in IT stocks.

IT stocks: Are they cheap or optically cheap?

India’s two largest software services exporters – TCS and Infosys – have been among the biggest wealth creators on the Street. According to Motilal Oswal Wealth Creation Study 2022 report, TCS created Rs 9.55 lakh crore wealth and Infosys Rs 5.8 lakh crore in the last decade.

However, lower-than-expected results by both the IT majors in the March quarter show that cracks are beginning to emerge with the worst being ahead of us.

Expectations for Second Half Growth

Industry analysts believe that the revenue growth guidance reflects clear weaknesses, but also leaves the scope for revised growth open in the second half of the year.

“Worsening sentiment in the US, weakness in communications and BFSI vertical, and higher scrutiny on discretionary IT spends are the key themes emerging from recent results of ACN/TCS/Infosys.

There are expectations that the IT sector may revise its growth guidance in the second half of this fiscal year. The sector may focus on growth areas such as core tech spending, as well as in-demand sectors such as healthcare and travel to improve its performance.

But, should we take contra bets on this sector?

Analysts are not very upbeat about buying IT stocks at this point.

They say one needs to be cautious about the sector unless clear signs of economic revival in the US emerge.

Cautious Approach Recommended

Kotak,

-The brokerage firm stated that the slowdown in growth is not limited to a few companies but is widespread across the sector, mainly led by BFSI, communications, and North America.

-The guidance of IT companies is based on aggressive assumptions of quick recovery, making them vulnerable to short-term margin corrections if demand does not recover as expected.

-The report also highlighted that companies are willing to carry extra costs to retain employees, which could further impact their margins in case of a demand slump.

-The brokerage firm has advised clients to steer clear of IT stocks that are trading at high multiples based on unrealistic growth and margin expectations.

Prabhudas Lilladher,

-Decreased its weightage on the IT sector by 170 basis points, citing near-term headwinds caused by a slowdown in the BFSI segment in the US and Europe, as reflected in reduced hiring.

-However, the firm believes that the long-term growth story in areas such as engineering design services, ERP, data analytics, digital, artificial intelligence, and supply chain remains intact.

-The firm also stated that it reduced weight in Infosys but increased weight behind LTTS.

Jefferies,

-On the other hand, has a buy rating on Infosys as it believes the valuations are attractive after the fall.

-It is the only Indian IT stock to have received a buy rating from the brokerage firm.

-The global brokerage has warned that companies with greater exposure to North America (LTIMindtree and Mphasis) and communications verticals (Tech Mahindra) may see greater pressures on growth in the near term.

JM Financial,

-Stated that cloud companies expect optimization and see weak growth in the near term.

-The brokerage firm said that the weak growth in the IT sector could have a flow-through impact on margins as most operating levers are ineffective sans growth.

-JM Financial has a cautious stance on the IT sector but has positive views on Infosys and Wipro.

-The company believes that a sharp correction in Infosys makes it a good buy and Wipro remains their anticonsensus buy.

-LTIMindtree and Persistent Systems are seen as having higher risk while Coforge is their preferred mid-cap pick.

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