Is this the right time to invest in the IT sector?

With industries and enterprises increasingly going the digital way, it can be estimated that technology spending will only increase over the long term

Technology continues to transform the world, and the demand for digital services is steadily increasing. However, over the past few months, IT companies that service this requirement have been under the weather owing to the markets they service coming under pressure. As a result, there has been a sharp correction of up to 30% seen in the share prices of certain listed companies. Owing to the latest round of correction, many of the IT names which had elevated valuations saw their valuation cool off to much more reasonable levels. The question this begets is, is this an appropriate time to invest in IT names?

Why consider IT sector now?

Post-pandemic, technology took center in almost all aspects of one’s daily life covering various touchpoints. Owing to the work-from-home culture gathering steam, practically every business opted to go the digitisation way. This led to an increased demand for IT services. However, two years later, the best of the demand cycle seems to be behind for the sector. Furthermore, the developed economies, the major markets for Indian IT services, have been in a budget-tightening mode owing to a bleak economic outlook in their respective economies.

Also Read | Indian IT industry: Times, they are a changin’...and fast

Hence, the near-term outlook seems challenging- both in terms of growth and profitability. This is not the first time the domestic IT companies have come under pressure. Earlier, during 2017-19, during the advent of digital adoption, Indian IT companies had hit a rough patch. Many wrote it off as a permanent slowdown due to falling maintenance spend following cloud adoption and automation. But all fears proved unfounded, and the IT sector picked up significantly in the subsequent period when the implementation stage kicked in. Similarly, over the past two decades, domestic IT companies have weathered various disruptive developments and globally sluggish economic conditions multiple times and have emerged unscathed. All of these experiences have enabled companies to plan better.

The road ahead

With industries and enterprises increasingly going the digital way and relatively lower penetration, it can be estimated that technology spending will only increase over the long term. Also, rapid digitisation has led to increased regulatory attention from data and privacy perspectives, leading to an increase in cybersecurity demand and spend. According to a recent Nasscom report, revenues for Indian IT services are forecasted to grow at 12.3% CAGR to an estimated $300-350 billion by FY26 from $196 billion in FY21.

Now, with currency gains, attractive valuations post the recent correction, impending economic recovery in the West, and relatively unchanged tech spending, there is room for significant revenue growth over the next three to five years. Also, Indian IT companies are poised to make the most of emerging opportunities in artificial intelligence (AI), data analytics, sensor tech, hyper-automation, cybersecurity, etc.

For a long-term investor who is willing to stay invested with at least a five-year investment horizon, the near-term headwinds offer an opportunity to invest in IT stocks in a gradual manner. Since the long-term growth outlook for the sector remains relatively stable, patient investors can expect healthy returns. If you are an investor who is unsure of how to proceed with selecting fundamentally strong IT companies, the easiest approach to resolving this dilemma is by opting for an IT exchange-traded fund (ETF) or an IT index fund.

In the case of a Nifty IT ETF, the offering replicates the Nifty IT index. This index constitutes the top 10 IT companies from the Nifty 500 universe. No single stock will have an exposure of over 33%, and the maximum exposure to the top three names is capped at 62%. To capture the changing trends in terms of company performance, the index is rebalanced bi-annually. This index effectively provides investors with an appropriate representation of the IT sector.

So, by investing in a Nifty IT ETF, an investor gets the opportunity to invest in some of the top IT companies in the listed universe in a cost-effective manner. For example, an investor for around Rs 31 can buy one unit of ICICI Prudential Nifty IT ETF. So, one need not wait to put together a sizeable sum to begin investing. An aspect investors should be mindful of is that one needs a demat account to buy an ETF. Those without a demat account can invest through an IT index fund.

To conclude, through a Nifty IT ETF, a long-term investor can consider making the most of the attractive valuation the sector offers at present in a convenient and cost-effective manner.

(The writer heads investment strategy at ICICI Prudential AM)