IT stocks no longer 5-year buy-and-hold compounding picks, says HSBC

In its Q1 preview note, HSBC on Wednesday said top six IT firms may report flat to slightly positive growth -- better than feared post the Liberation Day. This may herald the bottoming of an earnings downward cycle, the foreign brokerage said.

HSBC said almost every IT company in recent times has alluded to a strong pipeline led by vendor consolidation deals. These deals find presence in the pipeline of every company and, hence, at the industry level, it does not believe this provides a strong positive read-across.

HSBC believes the long-term stock return trajectory gradient for IT stocks will not only be lower than in the past, but stocks will also be a lot more cyclical around this mean path.

HSBC said IT stocks, especially top-tier IT companies, are no longer five-year buy-and-hold compounding stocks; they now require a lot more active management around their cycles and volatility, it said.

"We adjust estimates and TPs across our coverage. Our ratings are unchanged. We continue to prefer Infosys in large-tier and turnaround plays like LTIMindtree & TechM. Hexaware and MphasiS are our other preferred names in mid-cap IT," it said.

HSBC’s latest report comes amid a wave of downgrades on Indian IT stocks by several brokerages. JM Financial has downgraded Tech Mahindra to Hold, citing limited upside following an 18% FYTD rally. Emkay Global has also downgraded Tech Mahindra along with HCL Technologies. Meanwhile, ICICI Securities has cut its ratings on Coforge, LTIMindtree, and Newgen to Reduce from Hold, and has downgraded Tata Elxsi to Sell.

HSBC believes the June quarter is likely to perform better than expected, easing concerns that followed the post-election "Liberation Day" sell-off. Slight improvements in demand commentary are noted, but the brokerage does not expect this to act as a major trigger, given that stocks have already rebounded 5–50% from recent lows.

“Guidance changes across companies are unlikely; the net currency impact this quarter is positive,” HSBC noted, adding that it is adjusting its estimates and target prices accordingly.

The report also comes at a time when foreign institutional investor (FII) holdings in IT services have fallen to near 13-year lows, while domestic institutional investor (DII) ownership has also declined significantly in recent months.

BNP Paribas, however, views these depressed ownership levels as a potential contrarian signal. Historically, such lows have preceded periods of outperformance for the sector.

The brokerage highlighted that the domestic IT sector currently offers a dividend yield of 3.2 per cent — near a decade-high — which it sees as offering valuation support. It also noted that recent management commentary, deal wins, and lateral hiring trends indicate a broadly stable demand environment.

“We are adding Infosys to our list of top large-cap picks, alongside TCS. Persistent Systems remains our preferred mid-cap name, and we also like HCL Technologies,” BNP Paribas said. “However, we are downgrading LTIMindtree to Neutral following its recent run-up. We remain cautious on Tech Mahindra and Mphasis, and see a significant underperformance risk in Wipro.”