Market expert Sandip Agarwal from Sowilo Investment Managers has called for a fundamental reset in growth expectations for the IT sector, despite recent positive developments that have lifted investor sentiment. His comments come after a major large-cap IT company surprised the market by upgrading its FY26 revenue guidance to 3-3.5%, even as broader debates continue around artificial intelligence-led efficiency gains and long-term growth prospects.

Guidance Upgrade Reflects Low Expectations Rather Than Strong Demand

Speaking to ET Now, Agarwal emphasized that the recent guidance upgrade was primarily driven by the latest quarter outperforming modest expectations, rather than indicating a sharp turnaround in underlying demand conditions. He noted that even the upgraded guidance implies negative to zero percent growth, which represents a relatively low threshold.

"So yes, the Q3 performance has been slightly better than what was anticipated, and because of that, obviously, the guidance sees an upgrade. Even the upgraded guidance implies a negative to zero percent kind of growth, which is a very, very low ask. So, the numbers are definitely better," Agarwal explained.

While acknowledging the company's strong execution on margins and robust order book strength, aided by a significant NHS deal, Agarwal stressed that these improvements don't change the sector's fundamental structural challenges.

Sector Maturity Limits High Growth Potential

Agarwal's central thesis revolves around his belief that the IT services industry has entered a mature phase, which significantly constrains the potential for high growth over the medium term. He expressed skepticism about the sector's ability to deliver substantial growth rates, particularly for large-cap companies.

"The only thing where we have a difference of opinion on the sector is that we continue to believe, based on data, that this is now a very, very mature sector. Expecting any substantial growth, even double-digit growth, for large caps is very, very tough. I do not think that is going to happen even in the next three to four years," he stated.

Revised Growth Projections and Valuation Concerns

The market expert outlined his revised growth expectations across different segments of the IT sector, suggesting a more conservative approach to forecasting:

Agarwal emphasized that current growth expectations need to be reset to mid-single-digit to low-single-digit levels. He expressed particular concern about valuation metrics, noting that PEG ratios appear "very, very high" across most segments, with small caps being the exception.

While acknowledging that strong management quality, steady cash flows, and dividend appeal justify some premium, Agarwal believes current valuations remain stretched relative to the sector's growth prospects.

Cautious Outlook on Market Movements

Regarding Infosys, whose ADR jumped nearly 10% overnight, Agarwal maintained a guarded stance and cautioned against reading too much into ADR movements. He highlighted the complexity of predicting opening trades based on overseas ADR performance.

"It is very tough to give a call because we do not know how people are positioned. The correlation with ADRs has not played out in the past in a big way. ADRs have their own environment in which they operate—liquidity and a lot of other factors are there," he explained.

IT as Alternative to Expensive Defensives

Despite his cautious outlook, Agarwal suggested that the IT sector could serve as a "quasi-cash" alternative and potentially replace more expensive defensive sectors. He specifically mentioned FMCG as a sector where similar growth rates command multiples that are two to three times higher than IT stocks.

"This is a sector which is kind of quasi-cash slowly, and maybe a good replacement for much more expensive sectors like FMCG, where the growths are similar but multiples are two to three times more expensive than this sector," Agarwal noted.

Preference for ER&D Over Traditional IT Services

Agarwal expressed a relative preference for engineering and R&D (ER&D) focused companies over traditional IT services players, citing stronger long-term growth potential. He specifically mentioned LTTS, KPIT, and Tata Elxsi as companies likely to outgrow conventional IT services firms.

However, he acknowledged that valuation remains a significant challenge, as investors have already assigned much higher premiums to these companies, making them difficult to justify on valuation grounds.

Investment Rationale Remains Limited

Summing up his investment stance, Agarwal struck a distinctly cautious tone about the sector's current investment appeal. "I believe the sector is very, very expensive. Unless someone wants to replace something which is even more expensive with this, there is no real investment rationale in the sector currently," he concluded.

India's IT sector has commenced the earnings season with results that, while better than feared expectations, fall short of inspiring renewed investor confidence. Early reports from major players including Tata Consultancy Services and HCL Tech reveal a mixed picture where cost discipline and favorable currency movements are providing support, even as fundamental growth challenges persist.

Mixed Performance Indicators

Sandip Agarwal from Sowilo Investment Managers highlighted that the initial large-cap IT results have been "slightly better than what was anticipated," with both TCS and HCL Tech demonstrating effective cost management. However, he emphasized the importance of focusing on two critical metrics: the book-to-bill ratio and year-on-year constant currency growth.

The book-to-bill ratios for both companies showed reasonable stability, though this does not indicate any major demand revival or significant upside potential. More concerning is the persistent weakness in constant currency growth, which remains "very, very subdued" at levels below 5% across large IT firms.

Currency Benefits Mask Fundamental Weakness

Rupee depreciation has emerged as a crucial support factor for the sector's reported performance. While dollar-denominated and constant currency growth appears weak, translation benefits have provided a boost to reported rupee revenues and profits. Agarwal noted that "finally, for investors, it is the INR which also matters," acknowledging that currency gains and margin improvements are helping offset the lack of meaningful fundamental revenue growth.

Despite these supportive factors, valuation concerns persist. The analyst maintained that "on a PEG ratio basis, the whole sector is still very, very expensive and not attractive in our opinion."

Workforce Optimization and Operational Efficiency

TCS's approach to workforce management drew attention, with the company reducing approximately 11,000 employees during the quarter and nearly 30,000 since the financial year began. Agarwal characterized this manpower rationalization as "very, very reasonable," particularly given productivity improvements driven by artificial intelligence implementation.

The analyst praised Indian IT management teams as "very pragmatic" and "very calculated and measured in their approach," noting that failure to right-size operations could negatively impact margins and create operational inefficiencies.

Regulatory and Structural Challenges

TCS faced a one-time non-cash impact related to new labor code implementation, which Agarwal explained involves repricing future liabilities such as gratuity and leave encashment due to salary structure changes. While acknowledging maximum impact on organized sectors like IT and banking, he dismissed long-term concerns, stating that "the one-time impact is big, which cannot be considered as a recurring impact anyway, and the recurring part is very, very small."

HCL Tech distinguished itself with an 18.6% margin performance and upward guidance revision, delivering what Agarwal described as "definitely much better than estimates." This outperformance was largely attributed to the products and platforms business, which tends to be seasonal and occasionally delivers significant quarterly surprises.

Market Outlook and Investment Perspective

The analyst identified several structural challenges facing the industry, including market maturity and intensified competition. Post-Covid changes have lowered entry barriers, resulting in deal pipelines now featuring 10 to 12 bidders instead of the previous two or three, creating additional pressure on pricing and growth prospects.

Looking forward, Agarwal expects continued muted performance, citing factors such as furloughs in manufacturing-linked segments. He believes most IT companies could manage modest positive surprises this quarter, primarily because expectations have been significantly reduced. However, he concluded that "other than INR depreciation, there is no fundamental reason to be in the sector in the near term," suggesting that a meaningful correction in PEG ratios would be necessary to create attractive investment opportunities.