it stocks: why a correction may be appropriate for IT stocks but not an overcorrection

The stock market is reassessing information technology (IT) as its expectations have not been met that the industry will continue its meteoric run during the pandemic. Fourth-quarter earnings and guidance are seen as lacking by investors, who dumped IT stocks, although the numbers released by industry leaders Tata Consultancy Services (TCS) and Infosys are fairly decent. Their bosses have pointed out that the demand for IT services is strong and that they are seeing more and more business coming forward.

TCS CEO Rajesh Gopinathan sees no reason to expect companies to cut technology spending in the medium term. He aims to double revenue at India’s largest IT services provider by 2030. Salil Parekh, Gopinathan’s counterpart at Infosys, says the company’s revenue growth forecast for the year is his forecast. strongest for some time. Infosys has tailored its offerings to cloud platforms and the digital enterprise. The payoff was handsome as the world worked from home.

Unable to run growth code

Technology consultancy Gartner estimates that spending on IT services worldwide is expected to reach 8.5% in 2023 after rising 6.8% to $1.3 trillion in 2022. The estimate for the year current is a downward revision of a previous projection. But the company sees companies accelerating their technology investments to stay nimble in a disruptive business environment. According to Gartner, CIOs have the financial and organizational capacity to sustain investments in key technology areas such as infrastructure as a service.

Still, investors are worried about the excessive valuations of Indian IT companies. The Nifty IT index lost a tenth of its value in a month, and Infosys shares fell 9% in a single day after its results disappointed analysts on quarterly earnings as well as forecasts for the current exercise. Brokers are interpreting the slowdown in the United States as affecting tech budgets, and smaller Indian IT companies could face the brunt of downgrades as their valuations are fancier.

Shareholders are also struggling to accept Gartner’s view that IT service providers will be able to pass on their inflated payrolls to their customers. Management faces a foaming job market and inflation is catching up with services. At this point, margins are squeezed by incentives to retain talent. There are indications, however, that employee churn may have peaked. IT services, however, cannot remain immune to the broader inflation that works its way into wage contracts.

Costs of providing services are rising, as travel and visa costs rise as lockdowns are lifted. Disruptions to the supply chain due to the war in Ukraine could reduce companies’ income and discretionary spending, affecting companies’ digitization budgets. So far, IT services growth is quite broad across retail, manufacturing, healthcare, finance, technology and communications. Some of these vertical markets will be more vulnerable to high energy and commodity prices.

India’s exports of technology services have a cushion in their geographical distribution. Parekh, who met with customers in the United States and Europe, did not encounter undue concern, and Infosys continues to discuss major deals for cloud-based transformation. Gopinathan sees an opportunity in an international trade environment fractured by war and sanctions. “The dialogue is much more about growth opportunities,” he told ET. Gartner expects no direct effect of the conflict on technology investments.

When tomorrow comes

There are two opposing views on IT in the stock market. One that sees the industry hit a golden patch during the pandemic when businesses shifted to working from home (WFH), generating an abundance of deals and new revenue streams. This phase is over for foreign portfolio investors (REITs), who are the biggest sellers of tech stocks in the Indian market.

The second view, which resonates among domestic retail investors, is that technology is now at a tipping point that will bring a new wave of IT services revenue. Retail investors bought into this theme, although price-earnings multiples were above the long-term average.

The National Association of Software and Services Companies (Nasscom) supports this argument. He doesn’t see geopolitics, macro shifts and supply disruptions as upsets to ambitious export targets set by the industry. He estimates that the industry currently employs 5 million people, many of whom have digital skills. It is this segment of the workforce that has caused the great resignation as IT service providers attempt to respond to higher digital adoption and cloud-based services. Retraining should bring the labor market back to equilibrium in the coming quarters. Industry-wide attrition is expected to approach its trend rate of 15%. India’s skills gap in technology services remains among the lowest of major international markets.

Lower attrition rates will alleviate vital cost pressure for the industry and a key concern for investors. A squeeze on margins and declining business demand are the root causes of the pessimism that has offset healthy results and sound advice.

We can expect more sales by foreign investors as the IT pack releases its numbers. But these will be nested in a wider pullback as the global economic recovery is dragged down by inflation. Central bank actions will drive global capital back to safer assets. Valuations for Indian equities are high overall and the correction has been brutal for front-line sectors like financials and IT. The reassessment of the computer industry is more due to inflated expectations than a significant change in business outlook. A correction may be in order, but not an overcorrection.

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