I have often found that Sectoral tailwinds make a difference to eventual outcome and investing results. Ceteris paribus, when you invest with the grain, rather than against it, you tend to reap a much better harvest.
There are quite a few things that favour investing in IT stocks at the moment. I enumerate a few here:
- Economic recovery in DMs: There are visible signs of growth forecasts improving for the US and recovery in Europe as well. Based on client feedbacks, management commentary from some of the leading Tech companies points to a much improved demand environment. Client mining in terms of greater wallet share is another aspect that will play out with application services and outsourcing opportunities.
- Technology trends & Growth opportunities: Big Data platforms, Mobile applications, SMAC Stack services, Hybrid Cloud, Security systems, Business continuity planning are some of the growth areas. This is in addition to regular areas like Remote Infrastructure Management services, Enterprise applications and BPO/KPO opportunities. Another trend is outsourcing of some of the strategic areas to vendors with whom clients have longstanding relationship and integrated deals around such activities.
- Not impacted by Election results: Investors are cautious to put cash to work in equities at the moment due to the overhang of General Elections in India in May 2014, the uncertainty over their outcome, stability of whichever formation comes to power, and what kind of policy stance the new Government will have on various issues including on markets and the industry. Going by experience of 2004 and 2009, Elections results can make a difference to the direction of equity markets.
- Discretionary spend improving: During 2009-2012 period, Top corporates were holding back budgets in view of prevailing uncertainty in business environment. Some of that spend of discretionary type like say in BFSI, Energy, Utilities space is coming back in 2014. NASSCOM estimates are positive and vision is to take the industry to revenues of USD 300 billion by 2020. There will be further demand uptick going into 2015. This will surely benefit Indian IT companies.
- Low cost hiring advantage: Notwithstanding the domestic slowdown, India will continue to produce large pool of technical manpower in the years to come. Since human resource is the principal raw material for IT services, the industry will continue to enjoy low cost hiring advantage and a large pool to choose from at the entry level. This gets more pronounced given the fact that other industries are not hiring big considering low growth business environment in old economy sectors.
- Lower rentals on commercial property: Real estate sector, more particularly commercial property market, is going through pain in terms of lower offtake and consequently lower rates. Apart from manpower cost, next big cost for an IT services company is in terms of rental rate or cost of buying the office space. So in this respect also, the industry seems to be well placed.
- Minimal impact of interest rates: In general due to low capital expenditure, IT companies are debt-free or carry small debt on their balance sheets. That being so, the burden of interest rates is also low, and in case the interest rates do not reduce in the near term, one industry that will not be impacted is the IT industry.
- Favourable Currency: I have purposely kept INR depreciation as the last point in the list, so as not to cloud the overall judgment arising from a factor that in my view should not be the primary investment criteria for any investor. I don’t like when so-called fundamental investor projects currency as the main investment proposition. A 5 paisa day move in INR-USD starts changing the stock call of these analysts, without understanding the fine points of whether the company is going to benefit or incur a forex loss in next quarter due to its hedged positions. That said, it is an important contributing factor that cannot be ignored.
Sectoral tailwind for the next few quarters/years does not mean we overlook the company and its business fundamentals. After all, we invest in a stock, and not in a sector, for the medium to long term. You can always combine it with stock-specific approach that I always profess. Large cap IT stocks like TCS, HCL Tech and Infosys are priced well, and it may be better to look at opportunities in midcap space, the likes of Zensar, Polaris, Hexaware and NIIT Tech. Vendors that can provide value to their clients in critical applications on an enduring basis
I end with the usual caveat that no part of this post is an advice to buy and sell stocks and readers should do their due diligence and home-work well in their own interest.