Disclaimer: The below content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query. This article is just thinking out loud and to document my thoughts at certain points of time about a topic of my interest.
“Better three hours too soon than a minute too late.” – William Shakespeare
While the IT sector has made sort of a comeback since it April 2023 lows, the deluge of bad news seems to flow incessantly. Many companies have reported weak earnings and downgraded their guidance. Though stocks don’t seem to reach that negatively to the bad news. Does this mean that the sector has bottomed out? How the current valuations compare with previous IT sector troughs? Finally, what is the best way to invest in such a sector now.
A snapshot of NIFTY IT sector performance and valuation
When we look at the trailing returns, despite some stagnation since 2022, the performance is quite good. The current trailing performance over 3 years, 5 year and 10 years are above the historical median returns.
When we look at the valuations, it does appear that the IT sector valuation is still not below historical median valuation levels across all the three-valuation metrics. Given that most IT companies are still cutting guidance, it is unlikely that we are going to get a sharp recovery in earnings.
When I also look at the realized volatility of the sector, an important indicator of sentiments, it does not appear too extreme either. It has come down recently and does not indicate any signs of panic at all.
It may mean that we are probably likely to see a time correction in IT stocks in best case scenario. In worst case scenario, we may see a significant correction at index level coupled with a prolonged time correction.
Analyzing NIFTY IT performance and valuation at sector troughs
I analyze the past data and look at the times when the NIFTY IT sector index suffered the maximum drawdowns. I start with 2009 and identify 4 such periods when there were heavy drawdowns. I also include the 2023 lows and the latest valuation and performance statistics to compare them with past sector troughs. I notice that:
- Trailing returns over 3-year, 5-year or 10-years are normally very low, sometimes negatives and at most in single-digit. However, that is not the case at this year’s sector lows. Even at its lows, the trailing performance of the sector was in double-digits.
- When I look at the valuation, P/E at market troughs was significantly below the median level. The same is true for P/B or dividend yield. However, when I compare the current valuation with IT sector trough valuation, it is significantly above trough valuations. In fact, the current valuation of the IT sector, as mentioned above is still above historical median.
What I can clearly see that current IT sector valuation is far from trough valuation. In fact, it is far from even median valuations.
Does it make sense to invest in Indian IT at this time and if so, how?
What I have shown above is that NIFTY IT is far from being in attractive territory. Valuation, trailing performance as well as sentiments do not reflect extreme stress. Further, earnings upgrades are unlikely to come in a hurry. All of these factors indicate a period of consolidation and correction, perhaps. Hence, a lump sum investment in the sector or assuming that the sector is near its bottom will be a mistake. At the same time, it is impossible to perfectly time the market. As they say, only liars invest in the market at its bottom. So, we have seen a part of consolidation and correction and it may continue for another year or so. Hence, next 2-years may potentially be good time to invest in the IT sector mutual funds from 3 to 5-year perspective. The good thing about IT sector is that it is a profitable sector. It has very little or no debt and we will see a recovery in due course of time. I have personally used this strategy in pharma and auto sector and think that NIFTY IT may provide good entry opportunity over the next two years. Hence, it makes sense to me to start a SIP in this sector mutual fund scheme.
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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