Since the start of 2022, information technology (IT) stocks have significantly underperformed the Nifti 50 index. The index has fallen 27 percent, more than double the 12 percent decline in the Nifti.
This sharp decline comes after a strong upward movement in 2020 and 2021; In 2020, the BSE IT index rose by 57 percent, while in 2021, it rose by 56 percent.
However, the good fortune seems to have hit a stumbling block in 2022 as all ten stocks in the Nifti IT index posted negative returns. Of these, Tech Mahindra was the biggest loser, down 45 percent this year. L&T Technologi Services, L&T Infotech, Mindtree, Mphasis, Tech Mahindra, Wipro and Coforge also saw corrections of over 40 percent.
What caused the sharp decline in IT?
IT stocks were in high demand after the pandemic hit as governments globally imposed lockdowns to curb the spread of COVID-19. Businesses have raced to digitize their operations to enable employees to work remotely and stay connected to customers. As organizations turned to cloud computing and digitization, IT companies saw an increase in their business inquiries and conversions.
The order book for the country’s largest IT company, Tata Consultancy Services (TCS), jumped 17 percent year-on-year to $31.6 billion in fiscal 2021 and $34.6 billion in fiscal 2022. The company claimed this growth was led by cloud, cybersecurity, business application services, IoT and digital engineering.
Infosys signed major deals worth $14.1 billion in FY21. In FY 2022, the country’s second largest IT company signed major contracts worth $9.5 billion.
However, since the beginning of this year, IT stocks have undergone a sharp correction due to expensive valuation and margin squeeze concerns. The high demand for IT transformation during the pandemic has also led to high attrition in the sector. To control this, companies have taken wage hikes, leading to the aforementioned shrinking margins for IT companies.
Infosys’ attrition rate jumped to 27.7 percent in the quarter ended March 2022, up from 10.9 percent in the same quarter last year. Wipro’s attrition rate rose to 23.8 percent in the 2021-22 financial year, double the 12.1 percent in the previous financial year. Tata Consultancy Services also saw a decline of 17.4 per cent in the financial year 2021-22.
Slowing income growth is cause for concern
In addition to these challenges, several international brokerages have recently downgraded some Indian IT companies citing slowing revenue growth and risks to operating profit margins. JP Morgan ( JPM ) downgraded the IT sector to “Underweight” due to concerns over excessive growth and margins.
Moreover, while these companies have been experiencing high levels of revenue growth for some time, it could hit a snag. This is due to an expected slowdown in the US economy amid a spike in interest rates. In addition, since inflation is likely to take longer to subside, high EBIT margins may also be difficult to sustain.
In fact, JPM is targeting a 10-20 percent decline in valuations for leading IT companies, including TCS, Wipro and HCL Tech. However, the investment and financial services company maintains positive views on Infosys among the IT pack.
Is it a good time to buy IT stocks?
Analysts say that after the sharp correction, many IT companies are quoting reasonable valuations, which could encourage long-term investors to start buying IT stocks. “Many companies are quoting attractive valuations and long-term investors should start buying stocks through a systematic investment plan (SIP),” said AK Prabhakar, head of research at IDBI Capital.
L&T Technologi Services and L&T Infotech are the best choices in the IT space.