IT Sector: Between midcaps and largecaps, what should you pick? Here’s what experts suggest

The Nifty IT index has experienced a continuous decline, dropping 7 percent year-to-date in 2024 and around 6 percent in the past month alone. Concerns about an economic slowdown have adversely affected the sector's performance, leading to expectations of ongoing volatility and weak demand in the near future.

Moreover, in the fourth quarter of FY24, Indian IT firms have revised their forecasts due to weak demand and macroeconomic uncertainties, leading to a reevaluation of growth and margin expectations for FY25. This adjustment has resulted in lower growth projections overall and a bleaker margin outlook for some companies. Recovery expectations have now been postponed to FY2026.

This downward trend in the IT space has also been reflected in most of its constituent stocks, which have consistently posted negative returns. However, mid-cap IT stocks have witnessed a sharper fall versus large-cap IT stocks this year so far.

Read here: LTIMindtree vs Coforge: Which mid-cap IT stock should you pick for long term?

Mid-cap IT stock Coforge was the top loser in the IT space in 2024 YTD, down 28 percent, followed by LTIMindtree, down 26.5 percent. Meanwhile, other mid-cap IT stocks, Mphasis, L&T Tech, Persistent Systems also shed 17 percent, 14 percent and 8.6 percent, respectively.

Among largecaps, HCL Tech fell the most, over 10 percent, while, Infosys, Wipro, and Tech Mahindra lost 7.8 percent, 3.5 percent, and 1 percent, respectively. TCS was the only IT stock in the green in 2024 YTD, up 3.2 percent.

While the current trend is more positive for largecap IT, will it remain the same in the long term? Experts advise between mid-cap IT and large-cap IT, where you should invest for long term.

Read here: Nifty Bank vs Nifty IT: Which index should you invest in for long term?

Mohit Jain, Research Analyst, Anand Rathi Institutional Equities, prefers mid-cap IT stocks over large-cap ones.

Most of the companies within Nifty IT should give double-digit returns over the next 12 months. Between large and mid IT, midcaps offer higher returns despite volatility.

Abhishek ShindadKr - Equity Analyst - InCred Capital, also has a similar view, picking mid-cap IT between the two.

Tier-II companies have the building blocks to sustain the growth momentum in the medium term but the entry valuations are unfavourable. Tier-I valuations are favourable but earnings upgrade is limited. Hence, we prefer restructuring stories and Tech Mahindra continues to be our preferred stock pick.

On the contrary, Sumit Pokharna, VP-Research Analyst, Kotak Securities, favours large-cap IT over midcaps.

In Q4FY24, Indian IT companies have extended their outlook for weak demand and macro uncertainty, leading to the reset of both growth and margin expectations for FY25.

Reset led to muted growth guidance for all and a weaker margin outlook for select companies. Recovery hopes have been pushed back to FY2026. However, on the other hand, stock price corrections in the past few months have made valuations more palatable. Infosys is our top pick followed by TCS and HCLT. We like Cyient among the mid-tier. Further correction can make other mid-tier IT stocks interesting.

Read here: Amit Shah predicts THIS for Indian stock market after Lok Sabha election results

Trivesh D, COO at Tradejini, also prefers large-cap IT.

Rising US Treasury yields strengthen the dollar, making Indian equities less appealing to foreign investors. Additionally, the Fed's reluctance to cut rates increases borrowing costs for US firms, potentially curbing discretionary spending in the Indian IT sector. Finally, a weaker Rupee due to higher interest rates shrinks the returns foreign investors see on their Indian investments.

I am not pessimistic, but I am not highly optimistic about the IT sector for double-digit returns in 2024.

IT's two-year consolidation suggests a potential upside and historically strong sectors tend to rebound eventually. While double-digit returns are uncertain, some participation in the IT sector's recovery is possible.

For investors seeking stability, large-cap IT stocks offer a safer bet with their established track record and financial buffer during volatile periods. Midcaps, though offering higher growth potential, come with greater risk. Monitoring global factors and IT sector performance is key before making investment decisions

Read here: IT sector FY25 outlook: Uncertain macros to weigh on revenue growth

Vaibhav Jain, Share.Market Research, has also chosen large-cap IT.

Between large and mid-cap IT stocks, given large-cap companies facing headwinds, it may be worse for mid-cap stocks. Also, mid and small-cap segments as a whole have been more volatile, beating the mid-cap IT stocks further down. Hence, from a slightly longer-term perspective, large-cap stocks seem to be better placed from a risk-reward perspective.

A major chunk of the revenues of large IT companies comes from America and Europe. Most IT companies failed to meet their revenue growth guidance, amid rising interest rates in the US and geopolitical uncertainties in Europe. Only pockets of resilience were demonstrated by some of the biggest players, like TCS. The US will hold presidential elections in November 2024. Consequently, there are uncertainties around US economic policies and interest rate trajectory.

Mid-tier technology firms, which have been growth performers given their size, have also been affected by the slowdown and expect volatility and slower demand to continue. Digital transformation continues to remain a key focus area of large global businesses. 

Read here: IT stocks see highest FPI selling worth ₹9,573 crore in April

However, the adoption is slow in Indian firms, for example, skilled employees in Gen AI space. Even hiring in the sector has slowed down, and there's a freeze on technology spending due to concerns about a recession and a challenging macroeconomic situation. The earnings guidance of most IT companies are in single digits.

However, it appears that the bad news may already be baked in as valuations for most of these stocks, from our factor model, look normal to slightly undervalued now. Although it may take a few more quarters for the PE rerating to take place, due to the above-mentioned headwinds in the sector, investors may find pockets of value in other sectors in the near future.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.