Investing is all about finding the right price for an asset. For the right price, you may sell an asset you have owned for a long time or buy a new one. On the sell side, it is about appreciation in value; on the buy side, it is about fallen value. For many years, information technology services (IT services) stocks like TCS, Infosys, Wipro, HCL Tech were bellwethers. No matter the domestic situation, the export of software was a secular global market demand. Indian companies excelled in offering services that large foreign corporations needed since 2000.
The dramatic disruption due to advances in artificial intelligence means that technology is eating into the same business that perhaps helped build those smart software codes. Once modern computers know a programming language, they can write software to achieve clients' desired outcomes. After pricing services by man-hours, software services companies began charging per line of code. It is hard to justify pricing now that the basic codes are not written by humans.
The Nifty IT sector index is down 16% this year, while the Nifty 50 index is flat. A significant chunk of that slump is attributed to fears about the durability of the business model in an AI world, rather than short-term profitability, according to Kotak Securities' analysis.
“For sentiment to turn,companies will need to demonstrate visible and sustained growth acceleration,” the brokerage said in a note on IT services recently.
What does it mean
The last thing you would want to do is panic and sell everything ‘technology’ you own. If you are a direct stock market investor, you may want to step back and take stock of the situation. Understand the impact of these developments on these businesses that boast of debt-free balance sheets and have historically paid dividends to shareholders. Can businesses be wiped out by disruptions? Sure, that applies to any business. However, most software services firms are well managed and do not carry the baggage of legacy manufacturing businesses.
The entire game in the software services is all about managing human resources. If you are tuning in to the latest quarterly financial results and related conference calls, you may know that hiring in the software services has already slowed. Whenever there was a headwind, software companies figured out a way to bounce back. This time, a section of analysts believes that repercussions of the AI-led disruption could be far deeper than just headwinds. That means businesses that can adapt and change their business models quickly will do better than those that do not. In the past, software companies have endured the dotcom bust in 2000s, the global financial crisis in 2008 and the COVID pandemic. They can pivot quickly to tackle the new challenges posed by generative AI. They have to figure out a way to become conductors of the ‘AI orchestra’ rather than just being labour providers.
When stock prices correct sharply, valuations tend to become cheap. However, if future profits are threatened or uncertain, it could be hard to find the right value. Buying into IT services stocks could also be like catching falling knives in the short-term. It may take a year or two for the companies to figure out a sustainable way to maintain or grow profits.
There is a lesson in diversification from the underperformance of the Nifty IT sector index relative to the Nifty 50 index. For someone new to investing, you may want to diversify across sectors with an index fund that tracks the Nifty 50 or Nifty 500.Starting with something considered cheap may not be the right way forward. It is also a topic you may want to discuss with your financial advisor. Treat what you read here as talking points for that conversation.