Investment Opportunities in IT Sector

Too many things have happened in too little time for the equity markets. And most of them unfavourable. The Budget did not please the industry and events in the international markets took a toll on the Indian markets as well. But in a crude sense, the Budget has let the IT sector free while bringing some of the high-growth industries like cement under the clutches of the regulator.

What makes IT stocks really exciting is the fact that the volatility of these stocks is in sync with the broad diversified indexes when compared to any other sector. Over the past one year, the S&P CNX IT Index is up by 25%, while the diversified Nifty is up by 12%. The IT Index has a volatility of 15% as compared to 12% for the Nifty. Considering the fact that the IT index has given double the returns of the Nifty over the past one year, it would be fair to assume that the volatility of the IT index would be almost double that of the Nifty at 24%. But the volatility of 15% for the IT index, at a time when bad news from overseas market is at its peak, is something that gives high comfort levels to fund managers.

However, contrary to what one would like to believe, investors had actually stayed away from this sector with the exception of Infosys and TCS. Over the past one year, TCS is up by 34% and Infosys is up by 42%. The other three Tier I companies — Wipro, HCL Technologies and Satyam Computers — have returned a growth between 3% and 10%. Momentum investors were busy cashing in on the construction sector, which at its peak level, was trading at a historical P/E multiple of around 400-times for some stocks. But now with the fall, valuations look real and the IT sector is expected to be back on investors’ radar.

Analysts are advising to buy low-risk IT stocks in terms of their betas. Beta is a measure of risk, where higher betas are considered risky. This, typically, means that investors need to stay overweight on Infosys and TCS since they have low betas at 0.95 and 0.86 and get out of Wipro, HCL Technologies and Satyam Computer whose betas are above 1. Incidentally, these other three stocks have lower P/Es of around 15 times when compared to Infosys and TCS at around 25-times. But since these stocks also have very high risks against the broad index, fund managers do not find their low P/Es attractive.

Buying this sector at a time when the companies are brought under MAT and stock options under FBT does not sound like a good idea. Even though the introduction of the tax is negative for the industry, the prices of these stocks are now adjusted for this change.

IT stocks fell by around 6-7% on the Budget day to accommodate for MAT, which is equivalent to the growth rate of the industry at 30%. The worst is over for the sector, and this is probably one sector that will maintain its growth rate of around 30% without any hiccups for the next few years to come.

Being overweight on IT makes sense as a recent survey of global chief information officers shows that the coming year will see a technology spending of 5-7%, which is in tune with the last year when spending had gone up in the same range of around 5%.

Tier I firms are reinventing themselves and moving up towards system integration and consulting. They are concentrating on higher value services so that margins can be maintained. The reason why IT will work for India lies in the fact that among emerging markets, only India has such high exposure to IT stocks. IT stocks are expected to be the safest bet as long as the world economy is growing and the rupee is stable against the dollar.