Why this is not the perfect time to join the IT bandwagon

This may not be the perfect time to buy them aggressively as the recent spike is due to lower valuations, say fund managers

While the stock market has been on a one-way rally, hitting new highs every few days, investors in information technology (IT) stocks would have been not a happy lot. For months, these stocks have been lagging the broader indices because of US President Donald’s Trump’s plans to tighten visa rule and the overall feeling that the Indian IT companies are lagging, in terms of technological advancements like artificial intelligence.

Thankfully, things seem to be improving. With the Trump government deciding not to make significant changes in its visa guidelines currently and chances that overall global growth will improve, there is a good chance that IT spends by companies will go up globally, and Indian IT companies are expected to benefit from this. Consequently, stocks of leading IT companies have risen quite sharply in the past three months. The Nifty 50 index, which hit 11,000 points on Monday, is up almost 8.44 percentage points in the past three months. The category average returns of technology funds is 25.26 per cent – the highest amid all equity schemes – in the same period. The next best performance has come from the category of small-cap funds – 13.49 per cent.   

So what makes IT companies attractive now? For one, lower valuations compared to other sectors. Anup Upadhyay, fund manager, SBI Mutual Fund believes that the sudden rush to buy the sector is mostly due to low valuations. “The sector is in a better position than before but the earnings growth would remain in single digits,” he says. And according to him, the IT sector will isn’t expected to outshine the domestic sectors in the next two to three years. “Stocks haven't started going up because of a fundamental improvement in the sector but more because of the sector rotation drive by uncomfortable valuations in rest of the market,” adds Upadhaya. 

Agrees Sonam Udasi, fund manager, Tata Mutual Fund: “Both Pharma and IT, which are export oriented in nature, are sectors that have not participated in this rally. Both of them have not performed as compared to the domestic sectors over the past one-and-a-half to two years. Our view is that, between IT and Pharma, valuations in IT are cheaper even today after the run-up. The IT sector is also cheaper relative to the market. Large caps in the pharma sector are trading at a valuation of around 23-24 times. The large caps in IT even today are trading at 20 or sub-20 kind of valuations.” According to Udasi, in earlier cycles the rupee-dollar equation was always in favour of exporters. Since the dollar has depreciated against other currencies, including the rupee, this has acted as a headwind. 

For investors, who are interested in this sector, the advice is that such themes do well only for a certain period of time. Investors in direct stocks should be more careful because while there are many big stocks in this segment, it is unlikely that they will do too well for some time. If there is a sharp correction in the market, these stocks may suffer as well. “And if there is a correction, there might be better opportunities to enter these stocks,” says a fund manager. 

On the other hand, existing investors can hold on to their funds if they haven’t made more than 40-50 per cent. If they have made this kind of money and there is no tax implication, they can book good profits. New investors need to more cautious before buying these schemes.

stocks