After pharma, IT stocks now start correcting

With information technology bellwether Infosys forecasting a challenging outlook for the rest of FY16 coupled with weakness in the broader market, the IT index has declined 4.5 per cent. This is only slightly better than the Nifty’s 4 per cent fall following Infosys announcing its September 2015 results on October 12.

Large-cap IT companies, such as Tata Consultancy Services, Wipro and Tech Mahindra have fallen 5.5-7.9 per cent since October 12. Infosys has outperformed with a 2.3 per cent decrease in its share price, despite giving a subdued guidance in the second half of FY16, thanks to reasonable valuation and improving fundamentals.

HCL Technologies has fallen the least among the large-cap companies as investors had already reacted to the negative news of a likely bad performance in the September quarter communicated by the company. The key highlight is that mid-cap IT players, such as Mphasis, NIIT Technologies, KPIT Technologies, Polaris Consulting and Services and MindTree have gained 5-29 per cent. Shares of Oracle Financial Services and Software, and Persistent Systems are down only 0.5-2.7 per cent.

Analysts attribute the reason for outperformance of mid-cap IT stocks to low valuation, better financial performance vis-à-vis large caps in the September quarter, optimistic outlook by almost all mid-cap companies and investors moving to some cyclical stocks, like automobiles.

The valuation gap between large- and mid-cap IT stocks has narrowed substantially. The average valuation of mid-cap IT companies, which traded at 14.3 times and 12.2 times for FY16 and FY17 estimated earnings respectively, on October 12, now trade at 15 times and 12.8 times for the same period. On the other hand, the average multiples for large-cap IT companies has come down to 17.8 times and 15.6 times for FY16 and FY17, respectively, from 18.7 times and 16.4 times.

Analysts expect the trend of mid-cap company shares gaining momentum to continue as their growth rates will be higher than that of the large-caps. Moreover, the large-caps are also struggling with growth rates due to a much higher base.