Indian technology stocks could offer a valuation-led recovery, but investors should treat the sector as a tactical opportunity rather than a long-term investment until revenue growth improves, Shreyash Devalkar, Head of Equity at Axis Mutual Fund, told CNBC-TV18.
Devalkar said earnings growth in India’s IT sector, particularly among large-cap companies, is currently below 5%. For the sector to offer a sustainable long-term investment opportunity, dollar revenue growth needs to move towards the high single digits.
“Till then, it will be more of a bounce-back trade, driven largely by valuations,” Devalkar said.
He added that valuations have become reasonable compared with levels seen seven or eight weeks ago. When dividend yields are also factored in, IT stocks could offer reasonable return potential.
Devalkar also highlighted the two-sided impact of the artificial intelligence (AI) investment cycle on Indian companies. While Indian IT services companies are exposed to changes in technology spending, several mid- and small-cap companies could benefit from investments in power infrastructure and data centers.
These companies are linked directly or indirectly to capital expenditure in the power sector and data center ecosystem, which has been closely associated with the AI investment theme.
What could drive a sustained recovery in Indian equities?
Beyond the IT sector, Devalkar said a sustained improvement in the Indian equity market would depend on lower crude oil prices and a cooling of US bond yields.
In his view, crude oil prices need to move closer to $70 a barrel for India’s macroeconomic outlook to improve significantly. He attributed the prevailing higher prices to geopolitical factors.
“Fundamentally, crude oil prices have to be closer to $70 a barrel,” he said, adding that a decline from current levels would change the equation for India dramatically.
Devalkar also pointed to AI-related capital expenditure as one of the factors contributing to higher bond yields in the US, alongside debt levels. A slowdown in such spending, accompanied by a corresponding decline in US bond yields, could further improve India’s investment outlook.
The recent cooling in US bond yields from their peak is already a positive development for Indian equities, he said. Devalkar noted that foreign institutional investors (FIIs) have had to weigh the attractiveness of US corporate bonds yielding 6-7% against the potential dollar-term returns from investing in India.
Earnings resilience supports market sentiment
The ongoing earnings season has also supported Indian equities, with corporate performance and management commentary proving better than expected despite elevated crude oil and commodity prices.
Devalkar said earnings growth so far has been upwards of 20%, although results from several mid- and small-cap companies are still awaited.
Margin pressure has been lower than anticipated, with the impact estimated at around 50-52 basis points. Companies have largely reported earnings upgrades or flat earnings, with relatively few downgrades.
While investors remain concerned about the second half of the financial year because of higher crude oil and commodity prices, demand has remained resilient despite these pressures.
“There is no major impact,” Devalkar said, pointing to credit growth and asset quality as indicators of the resilience in the economy.
He said the earnings performance so far has been one of the key factors behind the recent improvement in market sentiment.