Three Indian tech stocks to buy in a fast-changing sector

Indian information technology (IT) services companies have benefited hugely from the adoption of digital technology around the world. There are compelling opportunities in this sector, where corporate governance is generally strong and capital efficiency is high. On average, leading IT services companies have a return on capital employed (ROCE) of 50% (excluding cash), and the conversion factor of accounting earnings to free cash flow is around 90%.

Indian IT services occupies a dominant position in the technology services sector, providing cost-effective and scalable solutions for enterprises across the world. India’s IT exports are worth over $160bn per year (around 13% of total global IT spend), and have grown at an annual rate of 20% over the last 20 years.

Beating the tech-refresh cycle

Companies can stay ahead in this highly competitive sector by adapting to changing conditions quickly and decisively. While this is applicable to every sector, it is especially true of the IT sector, which has been disrupted by a “techrefresh” cycle at least once every five years. This phenomenon goes far beyond enterprises replacing their existing systems. It involves updating key elements of IT infrastructure, including customer interfaces, to maximise efficiency. Indian IT players have been agile, which has enabled them to gain market share in a fragmented industry in which the largest company (IBM) has just 4% market share. In 2010 Indian IT services supplied 6.7% of global IT services.

By 2021 this had almost doubled to 13%. The latest inflection point was in 2015 when the entire IT services industry was disrupted by digital transformation and the adoption of cloud-based services. These trends were further accelerated by the pandemic. Indian IT services companies have been making targeted investments in technology and delivery while up-skilling their workforce at scale.

Some of the bigger companies have also built a comprehensive suite of full-stack technology platforms (ie, an entire set of software). Mid-cap companies have shown resilience, backed by strong leadership and expertise. Indian IT firms emerged from the 2015-2020 tech refresh cycle with double-digit growth, led by strong traction in digital services, which is now a significant part of their revenues.

Three top stocks

Each of the following companies have invested heavily in building digital capacities and have developed expertise in their selected areas. Infosys (NYSE: INFY) is a $106bn company (by market cap) that provides business consulting and outsourcing services. It is India’s second-largest IT services firm and is an established global leader with a highquality customer portfolio and a strong presence in more than 50 countries. Mphasis (Mumbai: MPHASIS) is a mid-tier IT services firm and solutions provider, specialising in cloud and cognitive services.

It has a strong position in custom application development and management for banking and financial services. Persistent Systems (Mumbai: PERSISTENT) is a mid-sized digital engineering and enterprise modernisation company. Its niche position is founded on deep expertise in healthcare and life sciences, and in financial services, including adjacent areas such as health technology and financial technology.

Ayush Abhijeet is an  adviser of the Ashoka India Equity Investment Trust PLC.

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