Is It Good Time To Invest in IT Stocks?

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:

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.

Does Long Term Investing Really Work in Indian Stocks?

As equity investors, we have been fed on over-dose of long term investing benefits, compounding wonders, those 16% kind of returns y-o-y on BSE Sensex, all Richie rich stories from the developed world etc. It’s very easy for me to do a post on any of these topics loading you with quotations from Buffett, Graham, Munger etc. Then you would find many stereo type equity blogs talking about legends who professed “Hold it forever” kind of approach if you get hold of a good quality stock. 

I want to however begin the year 2014 on a more sober note with some hard questions. The question is does it work in Indian context? Does your portfolio beat retail inflation rates?

Now see this link from the Business Standard with the headline – “Many blue-chip stocks fail the inflation test” - The marquee names include Colgate, Hindalco, three Tata group companies (Tata Steel, Tata Global and Tata Chemicals), Ashok Leyland, SAIL, BPCL.  Investors in these and many other stocks would be surprised to find that their returns have been trailing retail inflation rates. Sensex itself has given returns of 2.11% CAGR net of retail inflation over the 20-year period.

This thought is certainly very disturbing for all advocates of long term investing in Indian equities. 

Point # 1 is if 20 years is not the proverbial long term, then what is? In any case we have seen in last 5-6 years of recent market memory that returns in many so called blue chip stocks have been stagnating or even negative. So merely giving “time” to stocks is not enough. Just allowing businesses run their course and doing SIPs may or may not work. Don’t be blind about the process you are following. Your current SIPs in Infosys, TCS, ITC, Asian Paints etc may or may not be able to beat the inflation in 2033, who knows…

Point # 2 is stocks like Colgate, Hindalco and Tata Steel are quality businesses from respectable business houses if you are looking at a multi-year cycle that is long enough to smoothen out the effects of cyclical industries like metals. 

Point # 3 is we are talking with survivorship bias. Actually, this is the most significant aspect for me. In other words, we are talking only about those businesses that have survived all these 2 decades and still not been able to beat the high retail CPI inflation that is prevailing in the country. On top of that, these are marquee names in India Inc. These are not some down the road type of companies where the odds of beating the average returns would anyway have been low.

Point # 4 is the real purchasing power in hands of the shareholders in these companies has been diminishing when they intended to preserve or enhance it in their retirement years. That was the central idea of such long term investing horizon in first place, right? But believe me, none of the institutional or PMS guys would highlight such hard questions lest their income & interests get impacted.

Ok, what do we then do? 

That’s the logical question – what do we then do? Go back to fixed income securities and good old bank FDs. No, that is not the answer. By no means that is the problem diagnosis or the prescriptive remedy to cure the ill. 

Equities, in my view, are a great way to enhance your purchasing power (net of inflation) provided you are reviewing what is happening to the business on a regular basis. Watch it every quarter, monitor the results, and check whether things are working out for the business and fundamentals are supportive of your investment thesis or not. My humble advice is don’t be a slave of some dumb process of SIP, keep reviewing the results. After this reality check, we may end up holding for very long term, that’s fine. Then you won’t be disappointed after 5, 10 or 20 years. You’ll have solid returns for having done that ground-work. On the flip side, if business and stock is not working out for whatever reasons, let there be no attachments – emotional or financial – just get out of it. We are only human, and make our share of mistakes. I never believed in holding forever theory anyway.

In either case, direct equity investing is for seasoned investors who have the core skills, temperament and staying power to reap rewards in the longer haul. If you are saying you don’t have the basic knowledge and traits required, I would say it’s better to engage a pro or somebody whom you can trust rather than burning your fingers, besides capital and time. Even with that, monitor the results regularly, can't leave investments in auto-mode.

Another sedate, less glamorous, advice on first day of this new year is to keep learning more and more so as to emerge better investors. Let’s all grow as investors, our investment growth will take care of itself.

With best wishes to all of you for a happy and prosperous 2014 and beyond!