Software: Scaling up!

The year 2003 has been a turnaround year for companies in the Indian software sector - 'turnaround' in the sense that most of the Indian software companies have witnessed some respite from the pressure that they had been facing on account of slowdown in the global technology spending for the past two years. Outsourcing became increasingly mainstream and some companies (like Wipro, Infosys, Satyam and HCL Tech) were able to garner large-size deals. Also, as the situation improved relative to the past couple of years, Indian software companies (especially the majors) saw reduced pressure on billing rates and strong volume growth. The stock market fortunes of Indian software companies continued with their traditional volatility patterns. Early this year (April 2003), much to the discontent of investors, software stocks took a plunge post Infosys' declaration of 'less-than-expected' earnings growth for fiscal 2004, only to bounce back in line with the overall rally in the markets. Especially in the month of November, many software stocks touched new highs - some based on fundamentals, and some on speculation.

If one were to consider the table above, there appears a stark similarity between most of the companies in that list - all of these have been among the major beneficiaries of changing variables of the Indian software sector. Take for example, Hughes Software. This company had been under throes of extreme pressure post the slowdown in telecom spending due to high degree of pressure on global telecom companies. But as the environment towards telecom spending improved and the company diversified its revenue stream and entered new areas like BPO, investors reinvigorated their faith in this niche player. And the effect is as seen in the table above.

Well, apart from the gainers as mentioned in the first table, there have been some companies that have been shunned by the investor community post a slew of poor performances from them in the past. Ironically, most of these companies were also involved in the stock market scam of 2000. It is nice to see investors not repeating their mistakes! But then, these stocks were witness to intense speculation in the latter half of the year.

All said and done, stocks from the Indian software sector have borne the brunt of intense speculation in recent times. Even among those companies that have gained substantially in this rally, most are now trading at stretched valuations.

What to expect?

While the outsourcing opportunity would continue to be huge for Indian companies in the year to come, investors need to keep a close watch on the fundamentals. Scalability (both by anticipating opportunities as well as moving up the value chain) would be a big factor for Indian software companies in their growth prospects going forward. And investors would gain from investing in those companies that are able to meet their clients' requirements on this (scalability) front.