RETURN OF THE SOFTWARE STOCKS

Software stocks are suddenly back in the limelight on the back of a stronger Dollar. As the dollar appreciates against major currencies and the Indian Rupee, it could provide a major boost to the bottom lines of IT companies. After lying low for more than 18 months, they could now emerge as the leaders of the next rally.

IT companies have already managed to take the US recession in their stride, as they have demonstrated by their Q1 results. They are expanding their market base by diversifying into Europe and Asia. India is also emerging as an important market with Infosys CEO claiming that margins are better on Government projects. Again their focus on products rather than contracts could become a source of steady revenue for these companies. Already Infosys' Finacle (Product for Banking services) is contributing more than 3% of its revenues.

The challenge for Indian IT companies is in moving away from a linear growth model where revenue growth is linked to growth in headcount. Revenue per employee for TCS is $ 51,320, Infosys is

$ 45,800 and for Wipro it is $ 41310. As against this global majors like Accenture have revenue per employee of $ 130,200. Therefore there is immense potential for the big 3 of Indian Software to substantially improve revenue without significantly raising the number of employees, by focussing on greater value addition.

Newer verticals like remote infrastructure management and bioinformatics hold great potential. These segments presently contribute very little to revenues, but going forward they could emerge as

major growth drivers, besides reducing dependence on traditional sectors like BFSI and telecom. Also the majors are trying to get into business consulting , which is a high margin business, though with limited success till now.

According to a report by research firm Gartner," Tata Consultancy Services (TCS), Infosys Technologies and Wipro Technologies will emerge as the nextgen IT service megavendors and threaten the reign of the current global majors—IBM, EDS and Accenture. These (Indian) vendors are increasingly being considered for strategic service deals, and will augment or, in some cases, replace today's acknowledged megavendors by revenue in this space by 2011.Top Indian IT firms have outperformed the megavendors by almost a 3:1 margin in growth rates, a Gartner report said. "The emerging megavendors have more than doubled their revenue in a four-year period, with the 2007 revenue being 2.6 times the 2004 revenue."

On the financials side Indian IT companies are now valued at PE ratios in the early 20'. These are historically low valuations notwithstanding their ethical managements and their business models. In fact, the PE ratios are similar to those witnessed during 2001 the worst of markets for these stocks, which indicates that markets are viewing the future prospects of these business as worse than those during the major crises like Y2K or 9/11 attacks.

To sum up, all the fundamental factors point to IT stocks being a great place to be in for an investor having a 1 year investment horizon. Of course, the clouds and worries are very much there, but without these, the stocks would not have been available at such low prices.