Earnings growth to spur impressive IT stock valuation

By Angel Broking | Published on 5th May 2021 | 14

Earnings growth to spur impressive IT stock valuation

The fourth quarter earnings season in India is well underway and will be watched keenly by analysts and investors alike, as corporate earnings make a huge impact on equity markets. Earnings expectations can affect stock valuations and returns too.

Earnings of some sectors are likely to be impacted by lockdowns across the states amid rising coronavirus cases. The IT sector is less likely to be impacted by these lockdowns as the industry has largely been resilient over the past year. Also, work-from-home norms and digitally transformed nature of the sector will ensure that business is not hugely impacted by lockdowns or surge in Covid-19 cases. Also, cloud adoption has increased across the sector and many verticals have seen a rise in tech spending which means the IT sector is benefited. IT companies have reported better than expected earnings in the second and third quarters as well.

Rise of the Nifty IT index

As a result of the IT sector seeing growth, in the March 2021 quarter, the Nifty IT Index went up by a little over 6.6 per cent in comparison with an increase of 5 per cent in the Nifty 50 index. In the fiscal year 2020, the Nifty IT index shot up 102 per cent, beating the 71 per cent increase in the Nifty 50 benchmark index. This is the index’s best performance in 10 years as investors and analysts persist with their bullish outlook on the sector.

Enhanced topline growth

The revenue growth of most companies announcing their results in the early phase have been led by IT services firms. These IT firms make up for almost half of the combined revenues of the early-bird samples. The IT sector earnings growth in the fourth quarter has seen a slight impact of the Budgetary announcement that goodwill cannot be considered a depreciable asset. This means that depreciation cannot be claimed on the goodwill of a profession or business.

The combined net sales of the companies in the sample increased 7.9 per cent year on year in the fourth quarter while the net profit went up by 5.3 per cent y-o-y for the quarter. Most IT companies managed to save on overheads such as travel, employee commute and catering because of the work-from-home schedule as a result of the pandemic. The savings meant that operating expenses were lower than the revenue growth in fiscal year 2021.

Big deal wins, digital transformation, rising demand

The earnings for the fourth quarter began on April 12; IT services firms have been largely expected to post robust results this quarter as there has been a rise in demand thanks to global businesses taking up digital transformation in earnest.

Also, leading IT services firms have won the most big deal wins in the quarter ended March; a Nasscom-MckInsey report pegs this increase in deals at 30 per cent. Brokerage firm Nomura had in January this year forecast that the Indian IT sector would see large deal wins for the next four or six quarters. The brokerage firm said the drivers for growth in the IT sector over the immediate to medium term would include access to a broad client base, a wider portfolio of offerings and digital capabilities.

Big deals ensure that IT services companies can trigger a rise in revenues and grow in double digits. As a result, technology stocks have performed well and have led the 2020 India stock market rally. Tech firms have managed to scale their business models and win global deals. Margins have also risen, leading to stronger valuations.

Meanwhile, India Ratings has estimated a 6 per cent median revenue growth for corporates in fiscal 2021 over FY2020, even as a second wave of coronavirus infections spreads across the states. The IT sector is expected to see improved growth on the back of greater demand, according to the India Ratings report.

Conclusion

The fourth quarter earnings season has shown that the IT sector has been performing well on the back of large deal wins, increased digital transformation, cloud adoption and work-from-home policies. IT stock valuation has increased as well, as a result of the earnings growth of IT majors. The IT stocks have seen a sound performance in the recent past; the Nifty IT Index put up its best 10-year performance with the index shooting up 102 per cent in FY2020. Brokerage firm Nomura has also estimated that the Indian IT sector will witness large deal wins for the coming quarters as well. To sum up, the IT stock valuation right now is being driven by earnings growth of major IT/ITeS firms.