Down but not out! Why this year’s worst-performing sector is still a good buy-on-dip play

The last two years had been stupendous for the information technology (IT) pack be it in terms of earnings growth or stock performance.

Valuations of several stocks more than quadrupled since the pandemic which drove the need for digitalisation across industries and sectors, bolstering order book of software firms to record highs.

But the US Federal Reserve’s aggressive monetary policy steps and the fret over an impending recession in the world’s largest economy has fizzled out the euphoria, making the stocks in the sector one of the worst performing in 2022 so far.

Given the challenges emerging for the sector to sustain earnings growth in the backdrop of a bleak outlook for their biggest market, is it time to shun away from the pack?

Market experts don’t think so.

The Nifty IT index has shed 22% year-to-date, underperforming the Nifty50 by a wide margin.

Nevertheless, Nifty IT has still fared far better than the technology-heavy Nasdaq Composite which has fallen 29% in 2022 so far.

“Even though we have seen double-digit fall in most stocks, they are still well above the pre-pandemic levels. So, I don’t think there is anything to panic about at this point,” a senior fund manager with a domestic mutual fund said.

The Nifty IT index is still overvalued when compared to the pre-COVID levels. Even after the recent correction, stocks such as Mphasis, Mindtree, and Persistent Systems are trading at a 33-45% premium to their 10-year average.


FURTHER EARNINGS DOWNGRADES?
The higher attrition and a sharp rise in wage costs have been the major dampeners for the sector as these headwinds saw profitability of most companies coming off the peak. And this is what triggered earnings cuts in the April-June quarter.

The challenges persist and will restrict margin expansion for most companies in the September quarter as well, but analysts don’t see major risks to revenue growth and also do not anticipate significant earnings downgrades.

The demand environment is expected to have been strong in April-September due to continued deal momentum, but one needs to be watchful on how the macroeconomic as well as geopolitical risks play out, especially in October-March, said brokerage ICICIDirect, as this will help gauge the growth trajectory for 2023-24 (April-March).

Even if there are headwinds to growth, most analysts believe that companies are better positioned to withstand it. Therefore, any dip in stocks post the earnings announcement should be seen as a buying opportunity, analysts said.

“(We) maintain our constructive stance on the sector, and the short-term volatility provides strong opportunity for absolute returns,” said HDFC Securities in a note.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)