India's information technology sector could be on the verge of a significant earnings recovery after nearly two years of muted growth, according to market expert Sandip Agarwal from Sowilo Investment Managers, who remains constructive on the industry's medium-term prospects despite recent volatility.
Speaking to ET Now, Agarwal said he had turned positive on the sector about six weeks ago after maintaining a cautious stance for more than a year. He believes several structural factors are aligning to support stronger earnings growth for IT companies over the next few years.
According to Agarwal, the artificial intelligence investment cycle is now moving beyond the initial hardware-intensive phase. The first leg of the AI boom was dominated by large investments in graphics processing units (GPUs) and infrastructure by companies such as Nvidia and AMD. While that phase generated extraordinary growth for hardware providers, he believes the next stage will increasingly benefit software platforms and, eventually, IT services companies.
"If you recall, one month or 45 days back, I changed my stance from extremely negative for 14 months to very positive. I have come on record not only on your channel but on multiple other channels as well, and I clearly said that from here there is a good upside in the sector to be made."
Agarwal explained that the massive hardware spending seen over the last two years was necessary to build the foundation for AI applications. However, he believes the industry is now entering a phase where software and services companies will begin benefiting as enterprises seek support in deploying and managing AI-powered solutions.
AI Adoption Shifting Toward Services
According to Agarwal, technology platforms such as Google, Microsoft, Anthropic and Grok are already benefiting from the AI wave and are likely to continue growing. The next beneficiaries, he argues, will be IT services firms that help enterprises integrate and utilize these technologies.
He expects the sector's growth rate, which has hovered near zero in recent years, to improve to around 6-7% annually over the next few years. While that may not resemble the high-growth years of the past, he believes it represents a meaningful turnaround for a mature industry.
Currency Tailwinds Could Boost Profitability
Agarwal also highlighted the role of currency movements in improving profitability for Indian IT companies.
He noted that over the last decade, many developed markets aggressively pushed localization requirements, forcing Indian IT firms to hire more local employees. As a result, the benefits of rupee depreciation were largely offset by higher operating costs.
Now, he believes much of that localization adjustment has already taken place.
"We have crossed those limits. So incrementally, from here onwards, whatever benefit the rupee gives, that benefit will show up in the PAT of most IT companies."
According to him, the combination of moderate revenue growth and a weaker rupee could significantly boost earnings growth over the next two to three years.
No Major Re-rating, But Earnings Can Drive Returns
While Agarwal does not expect a dramatic valuation re-rating for the sector, he believes earnings growth alone could generate attractive shareholder returns.
"I believe that there will be no re-rating of the sector. It will remain here. But this 70% PAT growth, which will happen because of multiple factors, means that even if multiples remain the same, this sector will give you 70% return in absolute terms over the next three years."
He argued that sector valuations have already corrected substantially from their peaks, with many companies now trading at much more reasonable PEG ratios compared to previous years.
How Investors Should Select IT Stocks
When asked about stock selection, Agarwal advised investors to focus on valuation discipline rather than simply chasing growth.
He cautioned against engineering research and development (ER&D) companies, arguing that while their growth rates may remain superior to traditional IT services firms, their valuations are still too demanding.
"Avoid any ER&D companies because the multiples are still expensive. Growth may be better than IT services, maybe two times better, but the multiples are still four or five times higher."
Instead, he recommends focusing on software services companies where PEG ratios are below 1.5 to 2 times.
Agarwal also warned investors against buying companies solely because they appear cheap.
"Some problems that companies have had over the last 10, 15 or 20 years—whether leadership issues or something else—will not change just because growth is coming back and there is a currency benefit. They are cheaper for a reason."
Preference for Select Large Caps and Small-Cap Software Firms
While declining to name specific stocks, Agarwal indicated a preference for well-managed large-cap IT companies and select small-cap software services firms.
According to him, many mid-cap companies belong to the ER&D segment and therefore continue to trade at elevated valuations. By contrast, some small-cap software services firms are available at PEG ratios below one, making them more attractive from a risk-reward perspective.
"In the small-cap space, software services is what we like. Those are available honestly at 0.8 to 0.9 times PEG ratio, which we are very comfortable with."
Margin Expansion Could Be a Powerful Earnings Driver
Agarwal believes investors should closely examine operating margins to estimate potential earnings gains from currency movements.
He suggested that a weaker rupee could lead to meaningful margin expansion across the sector, which in turn could translate into substantial earnings growth.
"The industry has gone through a pain of localization, which is now over. So, you will get all the benefits of currency going forward."
The Bottom Line
Agarwal's investment thesis rests on three pillars: a gradual recovery in IT spending driven by AI adoption, improved earnings leverage from currency depreciation, and more reasonable sector valuations after a prolonged correction.
While he does not foresee explosive revenue growth, he believes the combination of moderate business expansion and stronger margins could produce substantial profit growth over the next three years. For investors willing to look beyond near-term volatility, he sees the Indian IT sector entering a potentially rewarding phase of its cycle.
