NewsStocksQ3 IT Earnings Expected to Be Modest as Seasonal Factors Limit Growth, Says Market ExpertQ3 IT Earnings Expected to Be Modest as Seasonal Factors Limit Growth, Says Market Expert
Market expert Sandip Agarwal expects a modest Q3 for Indian IT sector due to seasonal furloughs reducing working days, particularly in manufacturing-linked businesses. He advises focusing on management commentary over numbers as client budgets are typically communicated in early January. Deal momentum remains weak with book-to-bill ratios around one, while structural changes see smaller players competing for deals once dominated by large incumbents. AI adoption is expected to support margins through reduced employee growth rather than drive revenue transformation, with recovery still 12-18 months away.
*this image is generated using AI for illustrative purposes only.
The December quarter is shaping up to be a challenging period for India's IT sector, with market expert Sandip Agarwal from Sowilo Investment Managers advising investors to prioritize management commentary over reported numbers as the earnings season approaches. Speaking to ET Now, Agarwal highlighted how seasonal factors and structural industry changes are likely to impact Q3 performance across the sector.
Seasonal Headwinds Impact Q3 Performance
The third quarter faces significant seasonal challenges that are expected to limit growth potential across IT companies. Agarwal explained that December month furloughs, particularly affecting manufacturing-linked businesses, have substantially reduced the number of working days available for revenue generation.
| Key Q3 Factors: | Impact |
|---|---|
| Furloughs: | Reduced working days |
| Growth Expectation: | Flattish for large companies |
| Margin Impact: | Minimal cost escalation effects |
| Overall Outlook: | Modest quarter performance |
"This quarter, as you know, there is a December month where there are furloughs on the manufacturing side, and because of that the working days themselves are low. So, expecting anything big in this quarter from any company is a little difficult," Agarwal noted. He anticipates modest quarters with flattish growth for large IT names, while margin pressures are expected to remain contained due to limited cost escalation.
Management Commentary Takes Precedence
According to Agarwal, this quarter represents one where forward-looking commentary significantly outweighs reported financial metrics in importance. The timing coincides with the traditional budget communication period when clients typically share their spending plans with IT vendors during the first week of January.
"In my view, this is a quarter where commentary has always been more important than numbers. In the IT world, the first week of January is when budgets from clients start getting communicated to vendors, and some colour of that most managements should be able to give," he explained. However, he cautioned that meaningful growth recovery remains distant, suggesting the sector may not see strong growth numbers for the next 12 to 18 months.
Deal Environment Remains Challenging
The deal momentum continues to face headwinds, with expectations remaining tempered even for early reporters like TCS and HCL Technologies. Agarwal noted the absence of major deal announcements during the quarter and expects book-to-bill ratios to remain around one or slightly below.
| Deal Dynamics: | Current Status |
|---|---|
| Major Announcements: | Limited in Q3 |
| Book-to-Bill Ratio: | Around 1.00 or slightly below |
| Market Competition: | Increased participation from smaller players |
| Traditional Advantages: | Diminished scale benefits |
A significant structural shift has emerged in the industry landscape, where smaller and mid-sized players now compete aggressively for deals that were once dominated by large incumbents. "The challenge is that a lot of these small and mid-sized players are now participating in every deal. If you see the top two Indian IT players, the return of the last four to five years on the stock is almost zero," Agarwal observed.
AI Impact on Margins, Not Growth
While artificial intelligence continues to feature prominently in deal discussions, Agarwal cautioned against expecting dramatic near-term transformation of company financials. He believes AI adoption will primarily support margin protection rather than drive significant revenue growth.
"You would not see much margin decline in the sector for the next few years because employee numbers will keep going slightly down, or revenue growth will be higher than employee growth for sure," he explained. The expert expects this trend to continue and accelerate, supported by currency tailwinds and reduced wage pressure.
Investment Strategy and Valuation Approach
Agarwal suggested a reversal of traditional investment preferences within the IT sector, recommending smaller companies over larger ones. He provided a clear framework: "You should prefer smallcap over midcap and prefer midcap over largecap. That should be the order because of the changing dynamics of the industry."
Regarding valuation metrics, he emphasized the importance of using PEG ratios instead of traditional PE ratios given the sector's limited growth profile. "PE ratio is completely misleading. There is no growth. When you look at the PEG ratio, you will be surprised that what looks expensive on PE is not actually expensive," he noted, while highlighting that ER&D-focused companies remain attractive despite current expensive valuations.
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