Understanding IT sector

Traditionally IT stocks have Median P/E (10 Years) as below:
TechM: Median P/E – 17.7, Current P/E – 18.72
Infosys : Median P/E – 19.4, Current P/E – 27.5
HCL Tech : Median P/E – 16.3, Current P/E – 19.7
TCS : Median P/E – 24.6, Current P/E – 29.0

Except TCS, All large IT service companies have traded at P/E range of 15 to 20, over a period of 10 years.

From my experience of investing in IT stocks since 2004, there have been periods of bloated P/E(s) which last for few quarters and then P/E generally revert to mean.

From this perspective, I believe that, Fair P/E of most the companies except TCS should be below 20, and for some it could be even lower, based on their margins and ROE and ROCE.

Going forward, following are tailwinds for IT sector:

1. Rupee depreciation may continue for few more quarters helping higher margins. It will offset cost pressures to some extent.
2. Partial WFH may continue for some more time, which may keep margins higher for next few quarters.
3. Cloud migrations and digitization/automation trends will continue for some time.
4. 5G Telecom aided business for companies like TechM which are mainly in Telecom area.

Headwinds:

1. Tough visa regulations and delays. Increase in Visa costs from time to time.
2. High inflation will demand better salary hikes for few more years, putting pressure on margins.
3. Rupee appreciation which may happen once Fed rate hikes stop or stagnate. This may or may not happen.
4. Smaller companies may increase competition to some extent for large companies.

Overall, it looks tough to take a call whether P/E reversion to mean will take little longer this time or not. An investor need to take calculated risk here, and prefer those IT stocks which have better margins, ROE and ROCE to be on safer side.

To me, valuations look rich except HCL Tech. TechM is low margin business hence my valuation band for TechM is lower than current P/E.

I may be wrong in my analysis.

Disc: Worked in IT industry for 25 years. Holding only HCL TECH now.
I do not track Wipro much hence not included in above list.