Sunday, Sep 25, 2022

Why Tech Mahindra, Wipro & Other IT Stocks Are Destroying Investor Wealth

Since the beginning of this year, IT shares have witnessed a sharp correction owing to expensive valuation and margin contraction concerns


Information technology (IT) shares have been massively underperforming on the Nifty 50 index since the start of 2022. The index dropped by 27 per cent, which is more than double the 12 per cent decline in the Nifty. 

This sharp drop comes after a strong upwards movement in 2020 and 2021; in 2020, the BSE IT index surged by 57 per cent, while in 2021, it soared by 56 per cent. 

However, the good run seems to have hit a stumbling block in 2022 as all ten shares in the Nifty IT index have given negative returns. Of these, Tech Mahindra was the top loser, descending 45 per cent so far this year. L&T Technology Services, L&T Infotech, Mindtree, Mphasis, Tech Mahindra, Wipro and Coforge have also seen corrections of over 40 per cent. 


What Led To The Sharp Selloff In IT?

IT stocks were in high demand after the pandemic struck when governments globally imposed lockdowns to curb the spread of COVID-19. Businesses raced to digitise their operations to allow employees to work remotely and stay connected with customers. As organisations pivoted to cloud computing and digitisation, IT companies saw a spike in their business enquiries and conversions. 

The order book for the country's largest company IT company, Tata Consultancy Services (TCS), in FY 2021 jumped 17 per cent annually to $31.6 billion, and in FY 2022, this rose to $34.6 billion. The company claimed that this growth was led by cloud, cyber security, enterprise application services, the internet of things, and digital engineering. 

Infosys signed large deals worth $14.1 billion in FY 2021. In FY 2022, the country's second-largest IT company signed large contracts worth $9.5 billion. 

However, since the beginning of this year, IT shares have staged a sharp correction on the back of expensive valuation and margin contraction concerns. The high demand for IT transformation in the pandemic also led to high attrition in the sector. To control this, companies undertook salary hikes, leading to the aforementioned margin contraction for IT companies. 

Infosys' attrition rate jumped to 27.7 per cent in the quarter ended March 2022, up from 10.9 per cent during the same quarter last year. Wipro's attrition rate rose to 23.8 per cent in FY 2021-22, double 12.1 per cent in the previous financial year. Tata Consultancy Services, too, saw its attrition figure hover at 17.4 per cent in the financial year 2021-22. 

Decelerating Revenue Growth Is Cause For Concern

In addition to these challenges, a couple of international brokerages recently downgraded some Indian IT companies citing decelerating revenue growth and risks to operating profit margins. JP Morgan (JPM) downgraded the IT sector to "Underweight" due to concerns about overgrowth and margins.  

Moreover, while these companies have been registering high levels of revenue growth for some time, this might hit a hurdle. This is due to the anticipated slowdown in the US economy amidst a spike in interest rates. Additionally, since inflation is likely to take longer to taper off, the high EBIT margins may also be tough to sustain. 

In fact, JPM is targeting 10-20 per cent downsides in valuations for leading IT companies, including TCS, Wipro and HCL Tech. However, the investment and financial services company maintains a positive outlook on Infosys amongst the IT pack. 

Is It a Good Time To Buy IT Stocks? 

Analysts say that after a sharp correction, many IT companies are quoting reasonable valuations, which could encourage long-term investors to start buying IT shares. "A lot of companies are quoting attractive valuations, and long-term investors should start buying shares through the systematic investment plan (SIP) route," said AK Prabhakar, head of research at IDBI Capital. 

L&T Technology Services and L&T Infotech are the top picks in the IT space.