IT Sector Check - Price-to-Earnings Expansion Explains Entire 12-Month Upside: Nirmal Bang

Nirmal Bang Report

Price-to-earning multiple expansion explains the entire return of both tier-I and tier-II IT stocks over the last 12 months as consensus FY25E earnings have seen downgrades.

While some in the market believe that PE multiple expansion is a precursor to the start of a consensus earnings upgrade cycle for FY25/FY26, we remain sceptics. We believe it has more to do with strong domestic inflows into equities. The tier-II PE premium of 32% currently versus tier-I we believe is due to the skewed inflow into midcap mutual funds as much as because of better future growth prospects.

The market is already assuming FY25 to be a slightly better year than FY24 and that there would be a pent-up demand driven revenue spike in FY26 (which is expected to add on incremental basis revenue a little short of that in blockbuster FY22).

And if PE multiples are already expensive on existing earnings, it would require a material upgrade to FY25/FY26 estimates for meaningful returns to be made from here on - unless one is betting on a further PE multiple expansion.

Going by the H2 2024 recovery talk by most IT players, a high probability of ‘higher for longer’ Fed Funds rate in the U.S. due to recent hotter inflation prints there and uncertainty around economic and immigration policies of the next U.S. administration, we do not think there is a material upside to the earnings estimate in FY25/FY26.

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