Planning to invest in IT stocks? Keep these points in mind

The IT sectoral index of the BSE has underperformed the 30-stock Sensex marginally over the last one year. While the benchmark Sensex has moved up around 3-4%, the BSE IT index is down by 2% in the same period.

If you are looking to invest in software services companies, here are some nuggets to keep in mind before pressing on the buy button.

Revenue growth

The IT services sector’s revenue growth had skid to just 6% in the first year under the pandemic (April 2020-March 2021). But it bounced back last year with 19% growth. This was the highest growth in eight years, partly driven by the lower base of the previous year.

This growth is expected to moderate this year given an expected tightening of IT expenditure by corporate houses amid the inflationary headwinds in the United States and European Union, which together contribute almost 85% to the sector’s revenue.

According to rating and research agency CRISIL, the IT sector will sustain double-digit revenue growth this fiscal year, at 12-13%, driven by digitalisation, strong demand for new-age technologies, and depreciation in the rupee. The revenue growth has support from the shift in various industries globally towards automation, digitalisation and digital transformation services in the wake of the Covid-19 pandemic.

In particular, spending on cloud infrastructure is expected to grow 50% by 2025. Also, given the increasing adoption of new-age technologies such as cybersecurity and Internet of Things, the digital share of revenue of Indian IT service players may cross 50% over the next one-two years from around 47% last year.

Operating profitability

On the flip side, while the operating profitability will also remain healthy, it could fall back to the pre-pandemic low of 22-23%, compared with around 24% last fiscal, due to rising employee cost and increasing travel expenses.

Net employee addition by tier I players was at an all-time high of 2.7 lakh last fiscal year amid high attrition. The attrition level peaked at around 21% in the fourth quarter of the fiscal year from around 10% a year ago.

However, margins will be supported by premium pricing besides maintaining a healthy offshore and onshore employee mix and reducing sub-contracting amidst rising visa approvals due to roll-back of protectionist policies in key service regions.