Stock Valuations of IT Outsourcing Firms Up

March 13, 2010

The Information Technology business in India has been making progress at a rapid pace converting cost benefits and technical superiority into swelling revenues for the last ten years. Although share prices of these IT firms have dwindled amid the recession phase, they are rebounding as a recovery takes form in developing markets.

As of 2008, IT stocks are higher by as much as a whopping 300 percent. Outsourcing giants like Infosys and Wipro have market values of $33 billion each. However, analysts warn that IT stocks may be ready for a break.

Stock valuations until now have surpassed company growth rates, say reports. Though India is expected to restrict credit in the near future, it has a hgh price/earnings ratio of 25. Wipro, for instance, trades 34 times its earnings and has a projected long-term growth of 16%. Similarly, Tata Consultancy Services trades 22 times its earnings, while Infosys trades 26 times- its earnings – this is almost twice Infosys’ long-term growth of 14.

Experts say that these shares have traded at lofty valuations, however, risks are adding up as well. For instance, Infosys traded at an average P/E of 20 in the last year, the stock is expected to decline by 25%.

Senior analyst at Leuthold Group, Jun Zhu, place IT consulting and services firms on the ‘Attractive’ list last October. However, it has been downgraded to ‘high neutral’ recently. He said that these outsourcing firms are at historical highs and have rebounded from the recession quite nicely. Zhu added that there is high expectation from this sector. The next downgrade for IT stocks is ‘Neutral,’ and this is likely to be a trigger for a sale, reports

Some of the other risks that have propped up include protectionism in the U.S., order delays, economic uncertainty, a probable decline in the dollar, all of which could cause a downswing in terms of results. Moreover, the rise of regional rivals like China and Philippines along with emerging competition in Latin America and Africa are also a threat to Indian outsourcing giants. And on the domestic front, higher levels of competition has led to price pressures on applications development and custom software writing.

N.G.N. Puranik from Mumbai investment bank, Enam, comments that the outsourcing business model is robust. Adding, “The industry can grow at 20% to 25% over the next three years, given a benign IT-spending environment.”

However, GCA Greater India Fund CIO Eswar Menon says, “On a pullback, these are good, quality companies. But the good news is priced in,” reports SmartMoney.


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