After a sharp fall, Indian equity benchmarks rebounded on Tuesday, but the Nifty IT index was among the few indices that was in the red, down nearly 4%. Sector major Tata Consultancy Services (TCS) reported March quarter earnings, which were in-line with expectations, yet the stock fell 5% intraday on the NSE on Tuesday. As pointed out in this column, expectations around TCS' earnings were running high and valuations would have sustained only if the company would have beaten earnings estimates by a decent margin.

Even shares of Coforge Ltd slipped more than 8% intraday on the NSE in spite of the company announcing an acquisition, which according to analysts is EPS-accretive. EPS is short for earnings per share.

"There were consistent earnings upgrades for the IT sector before the March quarter earnings began. TCS' results suggest that there isn't more room for further earnings upgrades and that has weighed on all IT stocks," said an analyst with a domestic brokerage house requesting anonymity.

It should be noted that TCS' shares have risen far ahead of its pre-covid peak and valuations of more than 30 times one-year forward earnings, investors were banking on high growth for some time to come. Analysts at Ambit Capital pointed out that TCS’s average annual growth three years before covid was at 7.8%, but the current share price assumes annual growth of around 12% for the next 10 years. While the TCS stock has seen a sharp bounce back, all of this and much more is already priced-into the stock.

"This correction in IT stocks is healthy because it brings valuations closer towards fundamentals. The valuations of IT stocks before the result season were pricing-in aggressive growth expectations which were unreasonable," said another analyst requesting anonymity.

Meanwhile, Coforge has announced acquisition of SLK Global, a BFSI-focused business process transformation company for $195 million. "The company acquired SLK Global at a reasonable valuation of 2.6 times revenue. While we don’t see a material impact on FY22E profit after tax from this acquisition (due to amortization costs), this deal should add to Coforge’s revenue growth and profitability," analysts at Motilal Oswal Financial Services Ltd said in a report on 12 April. Investors should note that this acquisition comes with a five-year minimum revenue commitment from Fifth Third Bank and adds it to the top five clients of Coforge.

Although IT stocks have corrected, this does not mean that their performance is lagging behind. In fact, TCS' exit rate in Q4FY21 suggests that it will easily grow in the mid-teens in FY22, but as pointed out earlier, the problem was with expectations rather than performance.