IT stocks maintain their lead, Nifty IT up 38% YTD. Is there more steam left?

IT stocks are having a stellar run with the sectoral gauge, Nifty IT, returning 38 percent so far this year, nearly double of gains in benchmark indices. In fact, the Nifty IT index has posted a return of close to 10 percent this month alone against Nifty50’s five percent gain.

The bull-run in IT stocks has stretched the valuations of some of the blue chips and yet there is no stopping for them for now. This begets the obvious question: how long the rally will continue?

Bigger sceptics may ask: has it become a bubble waiting to burst any day now?

Market experts remain largely optimistic on the sector given strong fundamentals and business outlook even though some do point at higher valuations. The Nifty IT index's weightage of 18 percent in the Nifty50 gauge is second only to financials.

Questioning high valuations, Geosphere Capital’s Arvind Sanger said, “IT stocks have gotten a little ahead of themselves because I think it has become a safe place to hang out right now. It is good but not great enough to justify the kind of multiples that some of these stocks are trading at.”

Wipro has been the top performer so far in the current financial year with a return of 53 percent, followed by Tech Mahindra (43 percent) and Infosys (27 percent). TCS has risen 12 percent during this period.

Most IT companies surprised analysts with their Q1 earnings and the positive outlook.

Also read: TCS Q1 profit misses Street estimates | TCS market value tops Rs 13 lakh crore

According to Motilal Oswal, Indian IT service providers staged one of the best growth performances in Q1, delivering strong sequential growth in dollar terms aided by broad-based growth across geographies and services. The FY22 outlook for most companies also saw an upward revision, led by a strong start to the fiscal year and a supportive demand environment, it said.

Management commentaries highlight a very strong tech-spending environment, led by Cloud migration-related work, the brokerage added.

Motilal Oswal was surprised by the numbers of Infosys, Wipro, Mindtree, Coforge, Persistent Systems and Zen Technologies.

The overall demand for IT and IT services has led to a re-rating of the sector, said AK Prabhakar, Head of Research, IDBI Capital, told CNBCTV18.com.

"Getting staff has become difficult as salary levels have jumped manifold in the last six months which would lead to these companies losing the low-cost advantage, and there is higher attrition.”

A rising concern for IT companies has been higher attrition as demand improves. Devarsh Vakil, Deputy Head of Retail Research at HDFC Securities, said: "Acquiring new talent at a higher cost or retaining existing ones with increased monetary benefits would mean higher pressure on IT firms' operating performances."

Vakil expects strong deal momentum and improving growth outlook ahead for the sector.

Echoing similar views, Prabhakar said the order flow looks very good for Indian IT companies, which should continue to help the sector retain its position as an outperformer for now.

Despite stretched valuations, IT is likely to outperform, said Vinod Nair, Head of Research, Geojit Financial Services.

“The acceleration of digital transformation in the western countries is driving business for Indian IT companies. Today, the clampdown on China's technology sector is sentimentally adding perception to the Indian IT sector,” Nair told CNBC-TV18.

“The focus is on largecaps and stable sectors which can sustain their business gains, and benefit from the unlocking of the economy. IT sector is the best pick in this situation and likely to outperform the market in the short to medium term despite high valuations driven by steady growth and outlook,” he added.

Mutual funds are buying aggressively, said Nischal Maheshwari, CEO of Institutional Equities and Advisory, Centrum Broking.

“If IT is performing for last one year and still we have large funds neutral or underweight on the sector, somewhere a catch-up will soon happen. That is what you are seeing now that some of these funds are buying aggressively,” Maheshwari told CNBC-TV18.

Within large and midcaps also, a catchup is happening, he added. “Tech Mahindra and HCL Technologies, have run up to 15-20 percent in the last one month. So some catch up is happening between the largecaps and midcaps now.”

On whether the IT pack is in a bubble waiting to burst, Rahul Sharma, Co-Founder of Equity99, told CNBCTV18.com, “The growth in IT stocks is backed by good fundamentals and the companies declaring good results. We don’t see IT stocks in any kind of bubble and expect this sector to continue to give good returns.

Sanjeev Hota, Vice President-Head of Research at Sharekhan, believes the Indian IT pack is nowhere close to a bubble. Indian IT companies saw a back-to-back quarter of topline growth, he added.

"Overall earnings have been good for the Indian IT pack, and not just largecaps, but even midcaps and smallcaps. Although some issues remain on the margin front, as some of the margins were below expectations, overall, it has been a strong quarter.”