Fund manager’s dilemma: Is IT a future star or value trap? – Economic Times

How to value a sector with a mix of slowing growth, falling margins, fair valuations, steady cash flows and good managements? That is the predicament fund managers are facing these days as they sit down to assess whether it's worth investing in the information technology shares such as Infosys, TCS, HCL Tech and Wipro among others.

Prima facie, technology shares appear to be ripe picks at this juncture because of their underperformance in recent years. The BSE's IT index has fallen 2.3 per cent so in 2016 against the 17.2 per cent gain of Nifty. From January 1, 2016, the technology index has dropped 10 per cent, while the Nifty has gained 19.50 per cent in the period.

Given the liquidity sloshing around that has made its way to shares of various companies with questionable prospects, it would have been just a question of time before technology shares too rebounded. But, fund managers are still in two minds on whether to lap them up.

What is vexing them is whether the shares would be future winners or value traps at current levels. Considered the harbingers of India Inc's relatively late burst into global corporate scene in the '90s, technology companies are increasingly becoming pale shadows of their past.

The IT Index is trading at a price to earnings (PE) ratio - a widelywatched valuations matrix -of 15 times earnings. The total market capitalisation of the tech bigwigs - Infosys, TCS, HCL Technologies and Wipro - is roughly Rs 9.2 lakh crore, which is about 7 per cent of BSE's total market capitalisation.

Though the PE ratio is lower than its 10-year average of 19 times, various fund managers still do not consider these stocks cheap enough given the haze over their profitability. Analysts said the sector's growth is expected to slow to 4-5 per cent in the coming years from 7-8 per cent in 2016-17, forecast by Nasscom.

Various industry insiders and analysts have given their verdict that most of these companies, including the bigwigs, are unlikely to survive in their current form over the next few years. Automation is making several jobs redundant and clients are likely to squeeze technology companies further to cut margins.

This will force companies to bring down costs to survive. A rebound in the US economy is unlikely to be much of help either immediately.

Still, investors are not in a hurry to write off the sector. The biggest reasons for this are sound compa ny managements and steady cash flows -at least till now. These pa rameters are must-have boxes in the checklists of most seasoned in vestors while selecting companies.

The logic is that a good manage ment and cash will enable a smooth transition for a company in turbulent times. The top four technology companies had total cash balances of Rs 41,000 crore as on March 31, 2017, though there have been differences between managements and shareholders on how to deploy this money.

But, fund managers are not ruling out a brief rally in technology shares if the rupee weakens after the 4.6 per cent run-up so far this year. The rupee closed at 64.74 against the dollar on Tuesday. HSBC's currency strategists expect the rupee to fall to 66 by the year-end. Usually , when the rupee weakens, technology shares run up. But, a rally should not be construed as a turnaround in the fortunes of technology shares as the sector's prospects will remain fuzzy in the foreseeable future.

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Fund manager's dilemma: Is IT a future star or value trap? - Economic Times