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Our Top Picks in IT Services

Look for Wipro and Infosys to benefit from the growing demand for outsourcing.

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With the global economy in flux, investors have raised questions about the growth prospects of IT service providers. This fear has pummeled some of the top-tier service providers we cover, and current prices suggest a significant curtailment of IT services spending in the near and medium term. We think this is unlikely, as hiring patterns and order pipelines indicate that the growth momentum remains strong in the near term. Continued customer focus on cost efficiencies should help outsourcing achieve higher penetration in the medium term. Against this backdrop, we think narrow-moat firms  Wipro (WIT) and  Infosys (INFY) trade at large discounts, offering patient investors attractive risk/reward opportunities.

Demand for IT Services Remains Strong Despite Economic Uncertainties
Though the global economy is on a slippery track, we expect IT service providers to hold their ground in the near term. We haven't seen any cracks in IT services spending so far, not even in discretionary consulting services. Recent commentaries from  Cognizant (CTSH), Wipro, and Tata Consultancy Services indicate that it has been business as usual in terms of deal signings in the past few months.  Accenture (ACN) recently closed its fiscal 2011 with record consulting and outsourcing bookings; its outsourcing bookings were its highest in the past seven years. Additionally, given the linear nature of the business model (high positive correlation between employee growth and revenue growth), we think employee hiring patterns are good leading indicators of growth. All top-tier players have good records on resource planning and have historically increased hiring primarily when they had good visibility on their future demand. In that regard, continued strong hiring by these companies backs up our outlook for a robust demand environment in the near term.

Swami Shanmugasundaram does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.