Since the pre-pandemic market peak in early 2020, the IT sector has been one of the star performers in the bourses. The weights of the big five IT heavyweights (TCS, Infosys, HCL Tech, Wipro and Tech Mahindra) in the Nifty 50 moved up from 13.28 per cent in February 2020, to 17.42 per cent by the time the index peaked in October 2021. These stocks have outperformed the index and have also done some good heavy lifting of the index. Outside of Nifty 50, the mid-cap IT stocks fared even better, with many of the prominent ones like Mindtree, L&T Infotech and Coforge significantly outperforming the large-cap companies.

The pandemic-induced lockdowns in most parts of the world accelerated digitisation trends. Further, the quick response in the form of unprecedented monetary and fiscal stimulus from central banks and governments respectively ensured companies got confident to spend. Thus, contrary to past recessions, the IT companies raked in record order flows that translated into better growth and financial performance quarter after quarter since the initial negative impact. The mid-cap companies delivered even better performance than the large-caps, as they were able to capitalise on the digital thrust more, which was large, relative to their size, benefiting them disproportionately.

So far, amongst the large-caps, except Wipro, the rest have managed to hold on well amidst market volatility in the last few months. Since the market peak in October last year, TCS, Infosys, HCL Tech, and Tech Mahindra stocks have lost only up to 2 per cent at most, compared to Nifty’s 10 per cent fall. Their valuations, which were already well elevated (Trailing PE in range of 29-37 times versus five year average range of of 17-27 times), thus continue to remain so. The valuations are even more stretched when it comes to the mid-caps, although these stocks have corrected more in the range of 13 to 30 per cent since October market peak.

However, as disruptions loom again with Russia-Ukraine crisis increasing possibilities of global slowdown, the Covid playbook is unlikely to play out for the IT sector. Investors must be cautious for the following reasons – one, this time a slowdown in global economy due to the conflict is not going to provide any additional thrust to digitisation; two, with inflation at multi-decade highs in the US and expected to shoot up due to the war-induced commodity spikes and supply chain disruptions, monetary or fiscal stimulus will not follow.

Three, the massive sanctions governments have imposed on Russia and the knock its economy faces will impact the operations of many global banks. Further, subdued confidence in capital markets and flows will also affect the banks badly. Banking sector is key to many of the IT companies, with BFSI accounting for over 30 per cent of revenues for IT majors like TCS, Infosys and Wipro.

According to many economists, risks of stagflation in developed countries have now increased, and with IT companies’ business predominantly export-driven and dependent on these economies, this risk has to be adequately factored.

The playbook
High BFSI exposure a risk in current context
Investors must focus on value relative to growth
Good opportunities likely to emerge as risks play out

We have been recommending investors to book profits wherever the stocks had zoomed way past fundamentals and were not offering sufficient margin of safety for risks that could play out. TCS, Wipro, Happiest Minds, Mindtree, Coforge, Persistent Systems, Tata Elixi and L&T Infotech are amongst them. However, all these stocks we have ‘book profit’ recommendation on are high-quality companies and can be bought at certain levels as correction plays out.

At the same time we have also taken a positive stance in select stocks such as HCL Technologies and Tech Mahindra and recommended that investors hold/buy HCL Technologies (up 26 per cent since call ), Tech Mahindra (up 58 per cent)

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