Five IT stocks to buy; target prices for 20 technology shares

Stocks to buy: Kotak Institutional Equities, which is mildly disappointed with the March quarter results of IT firms after a relative stability in the preceding few quarters, picked Tata Consultancy Services Ltd (TCS), Tech Mahindra Ltd (TechM) and Infosys Ltd, Hexaware Ltd and Coforge Ltd as its top stock ideas in the information technology sector. It feels that a combination of minor miss in growth estimates, unexciting total contract value, guidance below expectations and reality of GenAI-led  revenue deflation will keep pressure on valuation multiples intact. 

The domestic brokerage said IT firms are making reasonable headway in AI-driven opportunities, but believes it will not be enough  to compensate for deflation headwinds. 

"Offsetting growth headwinds amid high competitive intensity will be challenging, it warned while suggesting that margin headwinds would still be manageable by further flexing cost levers. 

IT stocks to buy

Kotak said TechM is an incumbent in telecom but the vertical faces lower disruption risks from challengers, a positive in a world of Gen-AI disruptions. 

"It can be considered a challenger in the enterprise segment. A turnaround is largely successful. The stock has re-rated on relative basis, limiting the extent of upside," Kotak said.

Kotak said Infosys and TCS remain vulnerable to GenAI disruptions given incumbent status. Healthy AI capabilities and domain expertise, strong client relationships and experience of navigating technology cycles will ensure growth similar to industry, it said adding that valuations are cheap and attractive.

"Share prices of Hexaware and Coforge have fallen sharply YTD and provide considerable upside. Both of them have a good potential to be net beneficiaries of AI-led disruptions and have healthy medium-term growth prospects. Good execution is key to fulfill potential," Kotak said.

Target prices for 20 IT stocks

Out of 20 IT stocks that Kotak tracks, the broking firm has 'Buy' on Coforge, Hexaware Tech, Indegene, Infosys, Sagility, TCS and TechM. Here are target prices for 20 IT stocks. 

AI Impact  

Kotak said AI deflation risk has started showing up and visible in the management commentaries. For example, HCL Tech expects 3-5 per cent annual deflation in traditional services, which comprise 40 per cent of industry revenue. 

Kotak said deflation risks seem to be manifesting significantly in managed services deals during renewals wherein vendors pass on a part of savings to be generated by future AI productivity benefits upfront to clients. 

"We expect AI deflation conversations to pick up in applications as well, given that it is among the most vulnerable segments to be impacted," it said.

IT sector Q1 outlook
Kotak expect relatively moderate growth in Q1FY27 than usual due to client-specific issues plaguing multiple companies. These largely stem from not enough uptick in the demand environment, especially with new pressures such as in healthcare payers and hi-tech, slower deal ramp-ups, pricing cuts in renewals due to competitive intensity and client demands for upfront cost savings justified by future AI benefits.

"Mid-tier will lead growth led by Hexaware and followed by Persistent and Mphasis. Hexaware has the lowest YoY growth among mid-tier, but will be the fastest to grow on a qoq basis. Strong growth will be driven by ramp-up of multiple large deals won in prior quarters, coupled with significant reduction in headwinds from client-specific issues," it said.

Kotak said pressure on valuation multiples can intensify if growth outlook slips further. Pricing pressure, insourcing and elevated AI deflation create downside risks to growth outlook, it said adding that LLMs and agents may also become more adept at IT services at a fast rate, while remaining economically feasible. 

"Reinvestment of savings generated through deflation in services will be important. The risk is lower if large part of it gets reinvested through routes such as new software development, cloud migration, data modernization, legacy modernization," Kotak said.