Why Are Alphabet And Microsoft’s Poor Results Bad News For India’s IT Sector?

With inflation being the most pressing concern for the global economy and central banks, including the US Federal Reserve, raising interest rates over the last two to three quarters, the outlook for companies and overall investor sentiment has dimmed.

Alphabet Inc (parent company of Google) and Microsoft Corp saw their shares fall 9.6 percent and 7.7 percent, respectively, on Wednesday, following lower-than-expected earnings for the third quarter that ended September and growing concerns about the global economic slowdown.
With inflation being the most pressing concern for the global economy and central banks, including the US Federal Reserve, raising interest rates over the last two to three quarters, the outlook for companies and overall investor sentiment has dimmed.

As the American tech titans face scrutiny, the Indian IT sector, which is heavily reliant on business and revenue from the US and other developed economies, is unlikely to escape unscathed. North American and European markets account for more than 80% of TCS and Infosys revenue.

What is harming the IT industry?

High inflation and sharp rate hikes have weakened the US economy’s growth outlook and forced businesses to cut IT budgets amid talk of a coming recession. Rising prices and interest rates have increased the cost of capital for American businesses and eaten into individuals’ disposable incomes, forcing them to cut back on spending. This has had a direct impact on tech companies’ products, services, and ad revenues. An unfavorable macroeconomic environment in the United States and Europe will keep order flows, business growth, revenue, and share prices of Indian IT majors on a tight leash.

How have Indian businesses fared?

TCS and Infosys, two of India’s largest IT firms, reported strong third-quarter results. TCS reported a net profit of Rs 10,431 crore for the quarter, up 8.4% year on year; Infosys reported a consolidated net profit of Rs 6,021 crore, up 11% year on year.

Analysts believe that because IT companies rely heavily on business and revenue from the United States and Europe, they will be under pressure. While India is perceived to be relatively well-positioned in the current global economic turmoil, the IT sector may suffer as a result of stronger global linkages.

How are IT stocks performing?

  • These concerns are reflected in the stock market performance of IT companies. The benchmark Sensex on the BSE rose 2% between April 1 and October 27; however, the IT index fell 20% during the same period. TCS (-15%), Infosys (-20%), and HCL Technologies (-11.7%) have all seen their stock prices fall.
  • Mutual funds have significantly reduced their holdings of software stocks over the last six months. MFs had 13% of their equity AUM in IT stocks at the end of March; by September, this figure had more than halved to 6.17 percent.
  • The MF’s holding of software stocks has decreased from Rs 2,62,314 crore in March to Rs 1,27,492 crore in September.
  • TCS announced an Rs 18,000 crore share buyback in March, while Infosys recently announced a Rs 9,300 crore buyback.

What is the outlook for the sector?

IT and technology company valuations rose sharply during the Covid-19 pandemic, riding the overall digital surge and optimism about their growth. Many analysts believe that their price-to-earnings ratio, which jumped from around 16 to 30 in 2021, is about to correct.

“During Covid times, there was an urgency to adopt digital, which led to higher growth expectations and sharp increases in IT company valuations.” Now, growth is slowing, and the risk is that if the US slows and the rising cost of capital eat into companies’ profits, the demand outlook will weaken further, putting valuations under even more pressure,” said the CIO of a leading mutual fund.

Analysts believe that if companies experience a decline in order bookings in any one quarter, valuations may be correct.

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