- IT sector PE has slipped to 14‑18x, delivering a 4‑6% free‑cash‑flow yield.
- Emkay sees a 6.5%‑18.3% upside with limited downside, turning marginally overweight.
- The feared AI‑driven contraction is likely overstated; efficiency gains could expand total spend.
- Macro risk remains low – IT exports still underpin India’s current‑account health.
- Model portfolio now includes Infosys, HCL Technologies and Indus Towers, while trimming weaker names.
You’re watching the AI buzz, but the real opportunity hides in the IT sector’s cheap valuations.
Why Indian IT Valuations Have Suddenly Become Attractive
After a wave of headlines warning of an AI‑induced collapse, the Indian IT space has been battered into a discount. Emkay’s Seshadri Sen argues that the market’s most pessimistic forecasts—predicting a deep, prolonged contraction—are a classic over‑reaction. The sector now trades at 14‑18 times forward earnings, a range unheard of since the 2015‑16 sell‑off, and offers a free‑cash‑flow (FCF) yield of 4‑6%. For value‑oriented investors, that combination of low price‑to‑earnings (P/E) and solid cash generation is a rare alignment.
How the Jevons Effect Counters the AI‑Induced Panic
The report leans on the “Jevons effect,” a 19th‑century economic principle stating that efficiency gains tend to boost total consumption rather than shrink it. AI may shave margins on individual contracts, but the technology also unlocks new use‑cases—automated customer service, predictive maintenance, and AI‑driven analytics—that expand the overall IT spend pie. In practice, firms that embed AI can deliver more output with fewer resources, creating a virtuous cycle of higher demand and larger addressable markets.
Moreover, outcome‑based pricing—where clients pay for results rather than hours—means that any AI‑driven cost savings are often retained by service providers, bolstering profit margins. The net effect? A potential upside to EBIT (earnings before interest and taxes) that exceeds the modest 0‑3% long‑term growth baseline Emkay projects.
Competitive Landscape: Infosys, HCL, Tata Consultancy and the AI Race
While the AI narrative looms large, Indian giants remain well‑positioned:
- Infosys has accelerated its AI practice, partnering with leading cloud providers and building proprietary models for banking and retail.
- HCL Technologies leverages its “Mode1‑Mode2” framework to blend legacy modernization with AI‑first product development, preserving existing revenue streams while chasing new growth.
- Tata Consultancy Services (TCS) continues to dominate in large‑scale system integration, where AI integration is a value‑added service rather than a replacement.
All three firms have strong balance sheets, low debt‑to‑equity ratios, and cash‑rich balance sheets, making them resilient to short‑term demand shocks. Their diversification across geography—particularly in North America and Europe—acts as a buffer against any localized slowdown in the GCC (global capability centre) insourcing trend.
Historical Parallel: The Mobile Revolution’s Impact on Indian IT
History offers a useful analogue. In the early 2010s, skeptics warned that the surge in mobile app development would cannibalize traditional IT services. Instead, Indian IT firms pivoted, becoming the execution engine for global mobile transformation projects. Revenue from mobile‑related services grew from less than 5% of total billings in 2010 to over 20% by 2020, offsetting any erosion in legacy work.
AI is likely to follow a similar trajectory. Early adopters will drive demand for integration, customization, and ongoing support—services where Indian firms excel. The lag between AI hype and enterprise‑ready deployment provides a window for these companies to capture market share.
Macro Ripple Effects of an IT Downturn
Even a modest dip in IT exports would reverberate across India’s macro fundamentals. The sector currently contributes a multiple of the nation’s current‑account deficit and underpins wage growth at many top‑listed companies. A sustained contraction could dampen consumer spending, hit retail loan growth, and pressure the rupee.
Emkay, however, rates this scenario as remote. Their base case expects GCC hiring to remain flat to modestly positive (0‑3% growth) and projects that legacy modernization projects—driven by the need to migrate to cloud and AI‑enabled platforms—will provide near‑term revenue tailwinds.
Investor Playbook: Bull and Bear Scenarios
Bull Case
- IT valuations stabilize at 14‑16x PE, delivering a 6%‑8% dividend yield.
- AI‑driven efficiency lifts EBIT margins by 150‑200 basis points, outpacing the sector average.
- Revenue growth accelerates to 5%‑7% YoY as global enterprises fund large‑scale AI transformation.
- Stock price appreciation of 12%‑18% over the next 12‑18 months, matching Emkay’s upside estimate.
Bear Case
- AI adoption stalls, forcing clients to renegotiate contracts and compress pricing.
- Margin compression exceeds 300 basis points, eroding free‑cash‑flow generation.
- Export headwinds trigger a 2%‑3% drop in revenue, pushing PE back above 20x.
- Potential downside limited to 8%‑10% due to strong cash balances and low leverage.
Given the asymmetric risk‑reward profile—limited downside versus a double‑digit upside—allocating a modest, overweight exposure to the sector aligns with a value‑oriented, long‑term portfolio.
Actionable Steps for Your Portfolio
Emkay’s model portfolio adjustments signal where the smart money is moving:
- Add: Infosys, HCL Technologies, Indus Towers, SRF
- Exit: Sun Pharmaceutical Industries, Gravita India, Mphasis
- Trim: Maruti Suzuki India, Larsen & Toubro, Craftsman Automation
Investors should consider a phased entry, targeting the 14‑16x PE band, and monitor margin trends and AI contract pipelines as leading indicators of upside momentum.