Valuation of IT stocks: Tactical retreat or irreversible decline?

Valuation of IT stocks: Tactical retreat or irreversible decline? – Mail Bonus

Markets are expansion machines. On the way up, it’s all about what can go right as they amplify greener pastures. On the way down, the projection takes a valid priority as the magnification moves to the more murky side. The nature of the animal is such that it can never take a realistic or objective opinion. It fluctuates between overshoot and undershoot. Since markets are born with magnifying lenses, it is the role of investors to have the opposite gear to avoid market misconceptions.

One sector that is receptive to this manic behavior is the IT sector. After a two-year monopoly, equities in this sector are being severely punished in the current downturn.

One wonders, what has happened to all these audio bits about super-digital circuits, secular cloud change, and so on. which pushed valuation in this sector up to stratospheric levels over the last 2 years. Has anything changed materially or is it just a change of lens? Why is there a sudden rush among brokers to lower IT stocks? It started with JP Morgan and Nomura. Now no stockbroker wants to be left behind in this new downturn. What explains this?

In our opinion, it is rather a reset of valuations than any material change in growth forecasts or the outlook for industries. There is more story-telling-price-action than the other. As is always the case in the markets, price action leads and then the narrative follows. It is ironic that despite the fact that securities brokers have lowered their target prices, none of them has lowered their economic growth forecast for FY23. Even for FY24, they are less sure about the slowdown in technology spending. Reductions are imminent due to fears of further depreciation.

So the next question that needs to be asked is, what triggered such a sharp price action in the IT index compared to Sensex and Nifty? To do this, we need to look at what is happening with NASDAQ stocks, as they are leading indicators of attitudes in the technology space. Taking that argument into account, the decline in NASDAQ stocks probably explains the deadly decline we are seeing in Indian IT stocks. It was widely known that NASDAQ stocks were in the bubble zone and the Fed’s action was much needed to shock it. As expected, the NASDAQ crash had a huge impact on global technology stocks. Indian IT stocks, which were far from valuing their historical average, had to bear much of the burden of NASDAQ exposure. Even after this sharp correction, the valuation in this sector is still far from their historical level and has yet to reach a reasonable valuation level, especially in the central part of the IT sector.

That said, none of the medium- and long-term drivers for growth in the IT sector have disappeared. Companies’ willingness to spend on digital transformations and cloud computing will continue to drive above-average industry revenue growth. But revenue growth is unlikely to translate into valuation growth as much of equities are still well above the historical average.

So in reality, not much would happen on the valuation side and the story ahead will be more about revenue reaching an expensive valuation than anything else. It is the best example that can be hoped for IT stocks. Finally, is it time for a time trial for technology stocks? Only time will tell. Watch out for interesting times!

(The author, ArunaGiri N, is the founding CEO and fund manager, TrustLine Holdings Pvt Ltd. Opinions are his own)

(Disclaimer: The opinions, recommendations, opinions and opinions of the experts are their own. This does not represent the views of the Economic Times)

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