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5 reasons why IT stocks underperformed in 2016
10-20% fall may make even a seasoned stock investor sit up and notice. And that’s probably why you will see a lot of frowns on IT stock investors’ faces. The BSE IT index fell nearly 11% between January and October 2016. Individual stocks like Infosys, TCS and Tech Mahindra too fell between 5% and 22% over the period.
And the latest results only enhanced the fall further.
Here’s why IT stocks underperformed this year:
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Slowing growth:
Plus, the IT companies also reported a slowdown in revenue and profit growth. Gone are the days when the industry grew in double digits. TCS reported a 7% year-on-year profit growth in the quarter to September 2016. This is much slower than the 10.1% profit growth in the quarter before that. Even revenues grew just 5.2% in the quarter compared to the year before and 0.3% from the previous quarter. Infosys reported 8.9% profit growth in the September 2016 quarter compared to the year before.
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Negative management commentary:
Investors feel reassured if the company sounds positive consistently. Both TCS and Infosys have given warnings about an ‘uncertain environment’ over the last few months. They cut the expected full-year revenue growth target in the September quarter results. This is the second such cut in this year. This means the slow growth is expected to continue going forward too.
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Lower spending by clients:
When IT companies warn about ‘uncertain environment’, they are essentially telling you that their clients are not spending enough on IT. This means less work for Indian IT companies. Many other orders have also been delayed. Many global banks have cut down their IT spending. This is why TCS saw only a 1% growth in the banking and financial services business compared to the previous quarter. This is worrisome because the banking business is the largest revenue generator. It generates 40% of TCS’ revenues.
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US Presidential election:
One reason for the uncertainty is that companies defer planning new projects during election time. The US—the largest market for Indian IT—will elect its 58th President in November this year. Who gets elected could change policy-making. This could be one of the factors adding to the uncertainty.
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Brexit:
22% of Infosys’ revenues come from the European region, more specifically the United Kingdom. Even for TCS, the UK happens to be the second-largest market, generating 13.8% of its revenues. Europe is its third-largest market, amounting to nearly 12% of its revenues. Both the UK and European markets face the uncertainty of Britain’s exit from the European Union. Most media reports suggest that the banking sector is likely to be affected by the divorce. This is probably why banks have cut down IT spending and postponed deals.
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Changing business model:
The entire world of technology is changing today. Digital, artificial intelligence and automation are the upcoming technologies in demand. The Indian IT industry, meanwhile, has built a business in IT support services. This requires basic coding and plain vanilla IT services. As a result, they are losing to competitors like IBM and Accenture. This means the Indian IT companies have to restructure their entire business model. This could make investors jittery.
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Replicating past success:
Of the two IT giants, TCS has had it worse. Its growth has been slowing for more than seven quarters, as per a report by Kotak Institutional Equities. This is because it grew quite fast in the last few years, quickly gaining market share. Now, the remaining market share is not easy to acquire. So it’s not easy for the company to grow as fast as it did earlier.
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$5.34 billion
Infosys currently has reserve cash worth $5.34 billion. This could come handy when it plans to buy more companies. After all, it is easier to buy an established team that caters to the new technologies than build one from scratch.
