3 Questions to Ask Prior to IT Service Investing

by Rakesh Sharma | June 1, 2011 9:33 am

The growth curve for mid-tier information technology (IT) service companies such as Infosys (NASDAQ: INFY[1]) and Wipro (NASDAQ: WIT[2]) hit a recession-related bump as corporate spending dwindled. With more bad news for the economy on the jobs front, the companies might have to toughen up for another bad season.

But the recession does not always mean low returns for your investment in these companies. Smart companies do the right things to provide value to their stakeholders. Here are three questions you should ask when evaluating the balance sheet for these companies:

Do they work with multiple customers in several sectors?

Marquee names such as IBM (NASDAQ: IBM[3]) and Accenture (NASDAQ: ACN[4]) did not feel the pinch of spending cuts because of the broad-based nature of their sales across sectors and customers.

In effect, they were not dependent on a single customer or sector for revenue, and the results of such dependence can mean income loss. For instance, British Telecom provided $300 million worth of business to Indian IT service providers. That number is now $100 million, thanks to the telecom behemoth’s shift away to other vendors.

Do they work in multiple geographies?

Although spending cutbacks have been global, growth in developing economies and the Middle East have made them attractive markets for IT service companies. While the U.S. still accounts for the bulk of revenues in the field, rising visa costs, coupled with political and economy uncertainty, have forced companies to look elsewhere for customers.

For Indian IT service companies listed on NASDAQ, domestic markets present a fast growth opportunity and a substantial revenue source. While MNCs already have a head start[5] in this space, some companies are making up for lost time in domestic[6] markets[7].

Have they moved up the value-chain?

Although no spring chicken, the IT service industry really came into its own during the so-called Y2K (or Year 2000) crisis, as thousands of software engineers were imported to work on clunky IBM mainframe systems. Since then, the industry has graduated to doing legacy software maintenance and development.

With increasing commoditization of such work, the logical next step for companies is to provide high-value consulting  work to clients. Established players such as IBM have been doing it for decades. However, companies such as Cognizant Technologies (NASDAQ: CTSH[8]), which provide high-value consulting, are fast catching up.

The reasoning is simple: While low-value outsourcing decisions are generally delayed or reduced during a recession, demand for high-value consulting remains because it provides value to clients by helping them do more with less.

As of this writing, Rakesh Sharma did not own stocks in any of the companies listed in this article.

Source URL: https://investorplace.com/2011/06/information-technology-answers-companies-invest/

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