Not expensive but not cheap either - Indian IT's current valuation picture

Valuations in the Indian IT sector are at a crossroad. They may have corrected from their peak but their are not at their historical levels either.

Let us first take a look at TCS, which trades at 25-25.5 times forward multiple. While that may be significantly lower than its peak of 32 times, but the average over the last three years, in the pre-Covid era stood at 20-21 times.

Same is the case with Infosys, which trades at around 21.5 times forward earnings, which is a sharp de-rating from its peak of 28 times. However, the historic three-year average multiple for the stock was 17-18 times.

So, while valuations may have corrected, they are still at a premium when compared to history.

Brokerages too are divided when it comes to the sector and its outlook.

UBS do not foresee a meaningful downside from current levels for the IT sector but expect the sector to trade sideways.

According to Kotak, the sector is stuck in a limbo. They believe the industry may face tough times in the first half of calendar 2023 before green shoots kick in only in the second half.

Ambit said it's still not the time to turn constructive on the IT sector.

Credit Suisse said it's time to be selective on the sector. They are only going with Infosys as the only outperform because the sector valuations are still expensive and there are still risks of earnings as well as valuation derating because growth is likely to moderate.

According to CLSA, there is possibility of trend reversal in the IT stocks after underperformance in 2022. However, they expect upside to be capped as valuations are expensive.

Therefore, CLSA is going only with a few selective names. First is Infosys, as it has a defensive portfolio and they have been aggressive on large deals.

Second, they expect margin for TCS to improve further and they also see a potential for a buyback.

CLSA also expects healthy growth in LTIMindtree and said that as institutional holding is very low, it may provide some sort of a base.

They are also positive on HCLTech as they expect the margin guidance to be revised higher by next year and it is this improvement in margin that keeps them positive on the stock.

For more details, watch the accompanying video.