Crisil: Mid- & small-cap IT stocks are expected to rise over 25%

Business

oi-Shoaib MD

By Shoaib Md

Published: Wednesday, July 6, 2011, 11:35 [IST]

Small and mid-cap companies catering to the information and technology industry are expected to see a rise over 25% from their current valuations. These companies are trading at a discount compared to their larger-cap peers. The cheap valuation provides them the opportunity to manage pressure on earnings, said Crisil, a credit rating agency.

"Currently, the valuation discount for small and mid-cap stocks compared to large-cap stocks is high at 65% vis-A -vis 45% in FY07 and 20% in FY08," said Tarun Bhatia, director - capital markets, Crisil Research. He further added "We believe that IT companies under Crisil coverage should register strong volume and stable earnings growth, and expect valuation discount to narrow during the current financial year." He said this in a press release.

It also said, the risk-reward ratio of mid- & small-cap companies appears favourable compared to large caps. The small- & mid-cap are trading at a one-year forward price-to-earnings ratio of less than 4 time meanwhile large-cap stocks are trading at 15-19 times.

The equity market reacted sharply to the margin-related concerns and ongoing uncertainty in Europe. In 2011, the CNX IT Index fell 10.8% where as Nifty's shred 8.3% during the period. Compared to this, stocks of small-cap software companies 18.5% since January.

“While demand growth is expected to be healthy, margins are likely to be under pressure as most IT companies continue to grapple with issues such as rising employee cost due to wage inflation and attrition, flattish billing rates, higher visa costs and higher tax rates," said Prasad Koparkar, Head – Industry and Customised Research, CRISIL Research. He further added, “We, however, do not foresee a repeat of demand-related concerns such as slowdown in the global markets as witnessed in H2FY09 and H1FY10."

Analysts from brokerage houses are of the view that the second quarter earnings will play a big role in deciding on investors interest in the information technology sector.

Investors will keenly follow the impact of macroeconomic deterioration on the demand and outlook of Indian IT companies, shifting of client spending priorities toward discretionary spending, positive pricing momentum and the impact of an increase in the number of visa rejections. All this will be taken in account to judge the revenue growth and margins in the upcoming quarter earnings.

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