Where To Invest In IT?

Over the last couple of years, the dynamism observed in the global macro economic factors and technological trends have moulded the IT industry into a different shape. While investors banking on the expected-to-be-unwavering Infosys and Wipro have seen negative returns so far, the high-growth trend has shifted to mid-cap IT companies. Taking into consideration the financial performance of IT companies over the last four quarters, we can come to a clear consensus on what is likely to capture investors’ fancy in the near future.

From the beginning of CY12, while the big three of the Indian IT industry i.e. Infosys, TCS and Wipro have yielded a 1.41 per cent return, the mid-cap IT companies, on an average, have yielded returns of 57.34 per cent. These figures unsurprisingly draw attention towards this polarisation. The global slowdown has resulted in increased IT spending cuts across companies. This has resulted in trends like disintegration of larger deals into smaller ones, increasing client focus on specialisation and customisation and the obvious focus on pricing.

Because these mid-cap IT companies have been driven by a business model that focuses on specific industry verticals to leverage expertise, they have seen a proliferation of orders. To cite a few, Infotech Enterprises focuses on utilities, telecom, content & engineering, manufacturing and industrial while KPIT Cummins has its sights on automotive and Polaris Financial Technology concentrates on banking, financial services and insurance. What this does more than giving companies industry-specific expertise is the ability to get larger deals in the verticals on account of association of the company with the industry.

Moreover, the deals for these companies are priced in sync with the global situation and services aren’t sold at a premium. Take for example the average operating profit margin for IT companies in FY12. While the average operating profit margin for large-caps has been 27.04 per cent with Infosys as high as 32.19 per cent, the mid-cap average stands at 21.05 per cent.

Average Sequential Growth (%) In The Last Four Quarters

In all the four quarters, companies with a market capitalisation (mcap) of less than Rs 5,000 crore (mid-caps) have shown higher growth in revenue and net profit than the big three. Moreover, this growth has been significantly higher, especially in terms of growth in net profit. Of these mid-caps, the performance of Hexaware Technologies, MindTree, NIIT Technologies, Persistent Systems, Polaris Financial Technology and Zensar Technologies have been rather consistent in terms of financial performance.

Though the aforementioned companies have seen tremendous capital appreciation in their stock prices while posing a significant downside risk YTD, they are still trading at price to earnings’ multiples which are less than the industry average. Moreover, having looked at the consistency in their performance over the last few quarters combined with their adaptation to global trends, there is lesser risk of things going wrong fundamentally. With this, our recommendation is in favour of Hexaware Technologies, MindTree, NIIT Technologies, Persistent Systems, Polaris Financial Technology and Zensar Technologies but with a very careful eye on the movement of these stocks - the caution being a result of the appreciation in prices so far.

Sequential Growth (%) In The Last Four Quarters