Rahul Shah, Associate VP of Equity Advisory Group at Motilal Oswal Financial Services, delivered a sobering assessment: investors should avoid IT companies entirely at this juncture as the sector grapples with fundamental challenges to its traditional business model.
The AI threat to India’s IT giants
The massive selloff was triggered by commentary from leading AI companies including Palantir and Anthropic, which highlighted how artificial intelligence is fundamentally disrupting the time-and-materials workflow model that has been the cornerstone of Indian IT revenue generation.
“The entire model of time and workflow economics which Indian IT is a main source for revenue is under disruption,” Shah explained in an interview with ET Now, emphasizing that the sector has already been “struggling with earnings and flattish growth” for the past two-and-a-half years.
Margin compression looms large
While gross margins for major IT companies currently range between 40-45%, Shah warned that aggressive AI investment requirements will significantly compress EBIT and EBITDA margins going forward.
The challenge is particularly acute for large-cap players like TCS, Infosys, and HCL Tech, which have seen sustained institutional selling. These industry leaders have posted anemic growth of just 3-3.5%, and the new AI imperative threatens to erode the margins they’ve managed to sustain.
Mid-cap innovation vs. large-cap stagnation
Some mid-cap IT companies that have proactively invested in AI capabilities have demonstrated sustainable performance improvements. However, Shah cautioned that valuation concerns remain paramount when considering entry points into these AI-focused players.”Market gives PE for growth, and when we do not see growth coming back, PE keeps getting compressed,” Shah noted, explaining the relentless underperformance witnessed across most IT names over recent years.
Bright spots: Textiles and defense emerge
While technology faces headwinds, Shah identified structural opportunities in other sectors:
Textile Sector: Post-tariff deal momentum with both Europe and the US has created a multi-year growth runway. Shah recommends staying invested or accumulating on dips, predicting the sector will continue performing well for the next two years.
Defense Stocks: Hindustan Aeronautics Limited (HAL) emerged as a top pick despite near-term volatility. Shah called any 5-10% correction “a very good buy and attractive buy for investors,” citing HAL‘s reasonable valuation, strong ROA metrics, and superior growth prospects compared to defense sector peers.
Power Sector: Tata Power delivered robust EBITDA and PAT performance, with Shah projecting steady 12-15% compounded returns, making it a “stay invested” recommendation.
Investment strategy in uncertain times
Shah’s overarching advice centers on sector rotation away from struggling technology stocks toward areas demonstrating structural tailwinds and sustainable growth trajectories.”There could be more nervousness in the moods of investors as well as companies,” Shah warned regarding IT, suggesting investors “swap to other opportunities and sectors” rather than trying to catch falling knives in technology.
The coming quarters will test whether Indian IT giants can successfully pivot their business models toward AI-driven services or whether the sector faces prolonged valuation compression as automation increasingly displaces traditional outsourcing revenue streams.
This analysis reflects expert opinion and market commentary. Investors should conduct thorough research and consult financial advisors before making investment decisions.