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    Midcap IT cos’ valuation premium unshaken by global rout; can this sustain?

    Synopsis

    For seven straight quarters, FIIs have trimmed their holdings in HCL Technologies. From 24.92% in the quarter ended December of 2020, FIIs’ holding in the company came down to 17.2% in the quarter ended September of 2022.

    Midcap IT cos’ valuation premium unshaken by global rout; can this sustain?Agencies
    Shares of information technology companies were the most battered in 2022 due to the global rout in highly valued stocks amid rising concerns of inflation and economic slowdown.

    Despite a sharp fall in stocks, most of these companies haven’t seen a major correction in valuation. What’s worth noting is that midcap IT companies are trading at a significant premium to their 5-year average, compared to the largecap players.

    A stock like Happiest Minds Technologies has corrected a sharp 72% so far in the current financial year. Even then, it is trading at a valuation of 59.9 times on a twelve month trailing (TTM) basis versus its 5-year average price-to-earnings (P/E) multiple of 26 times.

    Price-to-earnings or P/E is one of the most widely used parameters by analysts to determine the value of a company during an apple-to-apple comparison. However, investors must consider other parameters such as the company’s fundamentals, earnings growth trend, capital allocation, etc. before deciding on buying or selling a stock.

    Shares of LTIMindtree have corrected by more than 30% so far in the current financial year,

    but are trading at 49 times TTM basis, compared to the 5-year average of 27.9 times.


    On the other hand, Tata Consultancy Services is trading at 30 times TTM basis versus the 5-year average of 27.6 times, and Wipro is trading almost at par to its 5-year average.

    Frontline stocks like HCL Technologies, TCS, Infosys, and Wipro have fallen by over 11-31% so far in the current fiscal.

    The sell-off in frontline stocks reflects in the holdings of foreign institutional investors in the sector which has steadily come down in the last few quarters.

    For seven straight quarters, FIIs have trimmed their holdings in HCL Technologies. From 24.92% in the quarter ended December of 2020, FIIs’ holding in the company came down to 17.2% in the quarter ended September of 2022.

    However, FII holdings in midcap stocks like Persistent Systems, Coforge, and Mphasis have been largely steady.

    Can midcaps sustain premium valuation?
    Analysts are increasingly turning cautious on the sector as a recession in economies like the US and Europe looks imminent and poses threat to earnings growth in 2023-24 (April-March).

    Even though most companies manage to report double-digit growth in revenue in FY23, the performance may not repeat in FY24.

    “We expect aggregate growth (for the IT sector) to halve in FY24 to 6.8% with slight margin expansion and favour larger IT names,” brokerage Jefferies said in its report.

    “Recessionary pressures are likely to impact CY24 budgets too, which may drive further growth moderation and P/E derating, keeping upsides limited,” it added.

    Given that valuation and earnings of globally-linked IT services could come under pressure in a recession-like environment, BNP Paribas trimmed its exposure to the sector.

    Historically, the Indian IT sector has had a strong relationship with US real GDP growth, noted Credit Suisse.

    Based on its FY24 US GDP projection of 0.6% growth, the top 4 Indian IT companies' growth is expected to be around 7.5%, the brokerage said, which is lower than the consensus estimate of 10-12%.

    “While margins are likely to remain protected as major IT companies have significant levers, concern remains over valuations, as they are still trading at much higher premiums vs pre-Covid-19 levels,” Credit Suisse said.

    (Data inputs from Ritesh Presswala)

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



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    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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