Top 5 IT Stocks that are still Undervalued. Worth a Look?

The Indian IT sector is set to grow at a compounded annual growth rate (CAGR) of 11.4% in the next five years, making it one of the fastest-growing sectors in the economy.

The surge is a direct function of the increasing adoption of digital technologies, rising demand for cloud computing and data analytics services and the sector's expansion into new markets.

However, the sector is currently under pressure from the global crisis and recession concerns. Indian IT players rely heavily on the US and European markets, both of which face recession risks. This dependence could lead to a dip in demand for IT services.

Moreover, the recent banking crisis in these regions could impact the BFSI sector, a key revenue source for top Indian IT companies.

Despite the challenges, there are some undervalued IT stocks worth considering. These stocks are currently trading below their historical averages.

#1 L&T Technology Services

At the top of our list, we have L&T Technology Services (LTTS).

LTTS is a mid-sized niche Indian IT firm with a primary focus towards exclusive outsourced engineering and R&D Services.

Unlike its larger peers, LTTS undertakes complex design and engineering projects that require deep domain expertise. It operates higher up the value chain, which allows the company to attain higher margins on the services it offers.

But none of this has shielded the stock's valutaion.

The stock's valuation has declined significantly from its peak of 70x PE in January 2022 to 36x PE at present. This is a drop of 50%!

The current valuation (36x) is still 9% higher than the 5-year median PE of 33x.

LTTS caters to industrial products (19% of revenues), transportation (38%), telecom & hi-tech (19%), and process industries (24%).

It enjoys a well-balanced and diversified presence across industries in tandem with a strong reputation due to its heavy engineering-focused parent Larsen & Toubro Ltd.

Around 63% of the business comes from North America, 16% from Europe, 13% from India and balance 8% from the rest of the world.

L&T Technology Services Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	34.10%	9.98%	-3.20%	19.68%	21.93%
Operating Profit Margin (%)	22.40%	23.48%	21.31%	23.86%	23.94%
Net Profit Margin (%)	15.13%	14.64%	12.23%	14.62%	14.65%
Return on Capital Employed(%)	45.36%	42.51%	30.06%	35.44%	37.03%
Return on Equity(%)	35.51%	31.77%	21.58%	25.32%	26.09%

Data Source: Equitymaster

The rising demand for digitization, in the post-pandemic era, has driven LTTS' revenue growth in the past few years. While the revenue has grown at a 5-year CAGR of 15.8%, the net profit has grown at 18.3%.

The margins have been robust, allowing returns to expand. The 5-year average return of capital employed (RoCE) and return on equity (RoE) stand at 38.5% and 28%, respectively.

To know more about the company, check out the company's financial factsheet and the latest quarterly results.

#2 Affle India

Next on our list is Affle India.

Affle India is a leading mobile marketing and advertising technology company that offers a range of digital solutions to businesses. It helps transforms ads into recommendations, helping marketers to effectively identify, engage, acquire, and drive transactions with their potential and existing users.

Despite its leading status, the stock has not been immune to the pessimism in the market towards IT stocks. The stock is trading at a PE multiple of 56x, 1/3rd of its peak valuation of 163x in January 2021.

Additionally, the current valuation of 56x is at 23% discount to its 5-Yr median PE of 69x.

The stock has underperformed the broad index substantially. In the past year, the BSE Sensex is up by 10%, whereas Affle India has fallen 16%.

What's surprising is that this fall comes despite a strong fiscal 2023 performance. The sales are up by 40% and the net profits have grown by over 15%.

The company is confident of strong growth, going forward. In the June 2023 quarter, the company reported that its business has been growing faster than the industry over the last 3 years.

The business has been growing well, led by several acquisitions and increasing mobile penetration in the country. The revenue and profits have grown substantially, reporting a 5-year CAGR of 42.6% and 50.8%, respectively. The 5-Yr average RoCE and RoE stand at 30.1% and 21.4%, respectively.

Affle India Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	44.72%	50.33%	46.38%	49.03%	24.52%
Operating Profit Margin (%)	23.43%	27.30%	17.43%	21.07%	15.00%
Net Profit Margin (%)	13.76%	18.05%	10.58%	14.23%	13.50%
Return on Capital Employed(%)	62.77%	41.96%	22.29%	14.75%	10.00%
Return on Equity(%)	43.64%	31.13%	15.76%	10.94%	8.00%

Data Source: Equitymaster

The company's customer base has also expanded to include some of the big names such as McDonald's, Apollo, Byju's, Swiggy, Zee5, etc.

In the digital advertising space, Affle India competes with InMobi, a global mobile advertising and discovery platform, and other giants in this field, such as Google and Facebook.

It has recently expanded its services to include AI and ML solutions and is confident of the increased adoption of AI in the digital advertising space.

To know more about the company, check out its financial factsheet and latest quarterly results.

#3 Tata Elxsi

Third on our list is Tata Elxsi.

Tata Elxsi, a Tata group company, is a medium-sized IT firm well-known for its design and engineering capabilities.

At present, the stocks seems undervalued, trading very close to its long-term median PE. It is available at a PE of 57.5x, 13% above its 5-Yr median PE of 50.5.

Following a strong post-2020 rally, the stock went on to trade at a PE of 110x and 105x in April and August 2022, respectively. However, it has dwindled since, with the stock price falling by over 30%.

The fall comes despite the strong growth reported by the company. In the fiscal year 2023, there was a considerable rise in net sales by 28%, accompanied by significant growth in net profit.

However, ongoing worries regarding the future demand for IT have led investors to voice their concerns about the near-term headwinds. This has led to the stock price correction despite remarkable growth in business.

The company's stellar financial performance has surpassed all growth expectations. The revenue and profit has more than doubled in the past five years. They have grown at a 5-year CAGR of 17% and 25%, respectively.

Tata Elxsi Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	14.62%	2.08%	11.43%	34.80%	28.04%
Operating Profit Margin (%)	28.78%	25.01%	30.85%	32.84%	32.95%
Net Profit Margin (%)	18.16%	15.91%	20.16%	22.25%	24.01%
Return on Capital Employed(%)	51.68%	35.35%	42.50%	51.20%	51.80%
Return on Equity(%)	34.50%	25.20%	30.15%	37.23%	40.97%

Data Source: Equitymaster

The return ratios have also been strong, averaging 30% in the past five years.

A large chunk of Tata Elxsi's revenues (87%) come from designing products for the broadcast & communication, transportation and medical sectors.

The company is present across the world with Americas accounting for majority of revenues at 42%, followed by Europe (36%), India (17%) & rest of world contributing to 5% of revenues.

The products designed by the company have become an integral part of the numerous devices we use daily. These include home appliances, mobile phones, cars and vehicles (especially electric vehicles), medical equipment, and more.

And now, the company is venturing into a promising segment, the Internet of Things or IoT. It is expected that the Indian IoT market could grow at a CAGR of 13.9% between 2022-2027.

To know more about the company, check out its financial factsheet and latest financial results.

#4 HCL Tech

Fourth on our list is HCL Technologies.

HCL Tech is India's fourth-largest IT company, operating in over 52 countries. The company's key focus areas are BFSI, manufacturing, cloud computing, life sciences and healthcare, and media and entertainment. And it enjoys an impressive client roster.

The company has been ahead of the technology curve by investing in various partnerships. This is visible in the business performance.

The revenue and net profit have grown at a 5-year CAGR of 14.7% and 11.2%, respectively. This robust growth has led to a strong RoCE and RoE averaging 28.6% and 23.1% over the last 5 years.

HCL Tech Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	18.51%	16.15%	7.06%	13.62%	18.56%
Operating Profit Margin (%)	24.61%	25.33%	27.83%	25.22%	23.64%
Net Profit Margin (%)	16.75%	15.64%	14.82%	15.79%	14.63%
Return on Capital Employed(%)	31.02%	28.42%	27.23%	26.63%	29.71%
Return on Equity (%)	26.04%	23.87%	20.09%	22.22%	23.41%

Data Source: Equitymaster

Despite the leading status and a history of strong growth and profits, the stock is trading close to its historical average. It is available at a PE of 21.1x, a mere 6% premium to its 5-year average of 19.9x.

This performance mirrors the investors skepticism towards near-term slowdown in the IT sector. Mainly because the company has a bright future ahead of itself.

HCL Tech is present across the world with Americas accounting for majority of revenues at 56%, followed by Europe (27%), India (4%) & rest of world contributing to 13% of revenues.

The IT powerhouse has been adapting new technologies, the latest being the IoT, cloud computing and cybersecurity. The growth from these segments are increasingly a large source of revenue for IT companies.

Moreover, the company has been involved in the AI technology stack for the last two decades. It has been working towards developing AI technology, especially generative AI. Generative AI can produce various types of content, including text, imagery, audio, and synthetic data. It has 140+ projects at various stages of maturity from proof of concept to implementation.

To know more about the company, check out the company's financial factsheet and the latest quarterly results.

#5 Infosys

Last on our list is Infosys.

Infosys is India's third-largest IT company. The company's key business verticals include insurance and financial services (32% of the total revenues), which command a large chunk of the industry vertical, followed by retail (16%), and communications (13%).

The company's digital services-related capability in cloud computing, the Internet of things (IoT), big data and analytics and artificial intelligence (AI) is ranked as the best in the industry.

But despite its lineage and stellar historical performance, Infosys shareholders have also borne the pain of the offloading witnessed across the IT sector. In the past one year, the share price has fallen over 11% while the BSE Sensex is up 10%. And now Infosys is trading at a PE of 23.4x, a discount of 8% to its 5-Yr median PE of 25.4.

Much like its peers, the tech giant is also present across the world with Americas accounting for majority of revenues at 62%, followed by Europe (25%), India (3%) & rest of world contributing to 10% of revenues.

The company caters to financial services (32% of total revenues), retail (15%), communication (13%), energy (12%), manufacturing (11%) and others (17%).

While the company does warn of some near term pain from the waning demand in the US, the long-term prospects seem bright.

The company expects strong demand from its clients in the digital, cloud and data segment. This expectation is backed by the successes they have had in the past few years.

Infosys Financial Snapshot (2019-23)

	2018-2019	2019-2020	2020-2021	2021-2022	2022-2023
Revenue Growth (%)	15.88%	9.99%	9.47%	20.30%	21.12%
Operating Profit Margin (%)	27.88%	27.61%	29.95%	27.78%	25.78%
Net Profit Margin (%)	18.64%	18.33%	19.33%	18.21%	16.43%
Return on Capital Employed(%)	32.40%	34.01%	37.83%	39.96%	44.58%
Return on Equity (%)	23.80%	25.62%	27.52%	29.39%	32.30%

Data Source: Equitymaster

The IT major has grown its revenues and profits at a 5-year CAGR of 15.6% and 8.5%.

This growth has trickled down to the RoCe and RoE, which stand at a 5-year average of 37% and 27%, respectively.

The company has also returned excess cash to the shareholders in the form of buybacks. Over the last five years, Infosys has bought back shares worth Rs 304.6 bn from the market in three different transactions.

To know more about the company, check out the company's financial factsheet and the latest quarterly results.

Conclusion

The IT sector has become an indispensable element of business rather than just a cost-effective source, thanks to the rapid evolution of digital adoption.

Organisations are swiftly embracing futuristic technologies like cloud computing, IoT and AI to enhance customer experiences. The rapid growth of the sector in India is evident, driven by significant investments in research and development from numerous technology companies.

The IT sector is cyclical, and there will be periods of time when the valuations of IT stocks decline. However, the long-term outlook for the IT sector is positive, and investors who invest in undervalued IT stocks could potentially see significant gains in the future.

Despite the positive odds, investors must conduct their own research before investing in any stock. And ensure it matches their long-term goals and investment temperament. That is what successful investing is all about.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...