IT Sector: Huge Opportunity Beyond Infosys

Apurva Sheth

Wow!

What an action pack week it has been for IT stocks - especially Infosys.

Last week, I told you this is the best time to buy IT stocks. And since then, the IT sector has made headline news all seven days of the week!

Infosys has been at the center of the action. On 17 August, the company announced it would consider a proposal to buy back its shares on 19 August. This news was more than enough to cheer market participants who've been waiting for such an announcement since June. The stock opened gap up and ended the day with gains of almost 5%.

The celebrations didn't last long, though, as Infosys CEO Vishal Sikka resigned the very next day. Market participants were disappointed with this development and thrashed the stock badly. It's down almost 14% over the last four days.

Sikka's resignation was frontpage news on almost every newspaper across the nation, and the stock has been in the limelight ever since. For the financial media, Sikka vs Murthy is version two of Tata vs Mistry.

The stock has also been in the news because of the buyback - which will happen at a significant premium above the current market price. Almost every brokerage and financial media outlet has a view on whether to tender shares in the buyback or buy fresh shares.

It seems that the buyback offer is very lucrative for retail shareholders and there is opportunity to make some money. If you are still wondering what to do about the offer, you might want to check out Equitymaster Insider (requires subscription). I had a word with Ankit yesterday, and he told me his next few issues will cover the dynamics of buyback issues and what retail shareholders should do with the buyback offers from Wipro and Infosys.

Buyback offers are a good way to make quick returns with limited risk. But that should not overshadow the other opportunities in the markets and especially in the IT sector.

The sector could be in an uptrend till February 2019. Have another look at the chart I showed you in my last letter.

Greed and Fear Phases in the IT Index
Greed and Fear Phases in the IT Index

As you can see, the sector goes through rhythmic cycles of greed and fear every two years. The IT sector has gone through three phases of greed and fear each. It is currently in the greed phase, which means the NSE IT Index can move higher from these levels. This uptrend could last till February 2019.

I wanted a second opinion on the possibility of an uptrend in the sector. So I checked in with Rahul Shah, Co-Head of Research at Equitymaster, for his views on the sector. He showed me the following table.

Number of IT Stocks Among Open Positions or Live Trades
Service No. of IT Stocks No. of Open Positions % of IT stocks
StockSelect 4 21 19%
The India Letter 3 28 10.7%
Hidden Treasure 6 23 26.1%
ValuePro 1 3 15 20%
ValuePro 2 4 15 26.7%
Total 20 102 19.61%


This is the total number of IT recommendations across various Equitymaster services. Except for The India Letter, most of the services have a good percentage of open positions from the IT space. On average, one in every five open recommendations are from the IT space.

This tells us that even from a fundamental perspective, IT is offering many opportunities. And when technicals and fundamentals align, our chances of an upside explode. It's a 'Sone Pe Suhaaga' moment for IT stocks.

However, at the cost of sounding repetitive, I want to be clear that being bullish on the IT space doesn't mean that every stock in the sector will do well.

There are at least seventy actively traded software companies listed on the bourses. You need to be very selective with your bets as not all IT stocks will be able to ride this uptrend.

You need to make timely entries and exits even in companies that are geared for an advance. You also need to control your risk and maintain proper balance with potential rewards.

It would be great if you can do this all by yourself. But if you can't then you don't have to worry. We can help you out. Find out how!

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Market Notes

Does a Rising Rupee Really Hurt the Indian IT Sector?

Last time we told you the IT sector may have begun an uptrend that could last till February 2019. We said we'd spotted a rhythmic cycle of greed and fear in the IT sector that repeats every two years. As per the cycle analysis, the challenging times for the IT sector appear to be behind us and we could see the IT index outperform over the coming months.

We have also seen how the Nifty IT Index has been accumulating in an ascending triangle pattern and how a breakout above 11,000 could end the accumulation phase and confirm the start of a new uptrend.

Protectionist policies in the US were looming over the IT sector. The H1B visa episode made it difficult for market participants to be positive on the sector. Those days may be gone, but industry analysts have now come up with fresh challenges for the IT sector.

The new fear is currency fluctuations. The rupee has appreciated 7% against the dollar in the past few months fueled by strong foreign fund inflows, a weaker US dollar, and favourable domestic factors.

The experts claim that if the rupee appreciates further it could harm the IT companies' top line. This is because most IT sector revenue is in dollars, and, as the experts conclude, a weakening dollar and an appreciating rupee do not bode well for IT companies.

Before we jump to conclusions, let's have a look at the chart below.

USDINR vs The Nifty IT Index
USDINR vs The Nifty IT Index

We have plotted a comparative chart of USDINR and Nifty IT Index from November 2016 (the top in the USDINR). The rupee appreciated 7% from its November 2016 high of 69.04 till today. During the same period, the IT index appreciated 8.5%. In fact, the IT index bottomed just a week before the USDINR topped out.

This is contrary to the popular belief that a rising rupee and a falling dollar weighs on IT sector performance.

It's true IT companies are usually export oriented. And most Indian IT giants do derive more than 50% of their revenue from their US clients. So if the dollar falls against the rupee, it is logical to think the top line of IT companies would take a hit.

But it's not that simple.

A number of factors affect the sector at any given time. Surely a weak dollar might affect the sector's top line. But the impact is offset by other factors such as a strong domestic economy and foreign fund flows into the equity markets. These factors usually have a positive impact on Indian share prices, including IT share prices.

More importantly, 80-90% of IT company revenue is hedged against currency fluctuations. So even when the dollar falls, the overall impact on IT revenues is negligible.

Fears that an appreciating rupee will hurt the IT sector seem to be overblown. To be sure, though, we looked into fourteen years of IT sector history to separate myth from reality.

More on this next time.

From the Market Wizards...

'Trying to trade during a losing streak is emotionally devastating. Trying to play "catch up" is lethal.' - Ed Seykota

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