Code unknown: What is spooking IT stocks?

The latest developments in AI are threatening to upend the business models of IT services companies. And more pain could be in store for their stocks.

This is a Mint Premium article gifted to you. Subscribe to enjoy similar stories. Artificial intelligence (AI) has begun disrupting the software industry. Since early January, software stocks across the world have tumbled sharply on investor fears that much of the business that software companies do will be taken over by AI, and by new AI giants such as Anthropic and OpenAI, among others. These companies, along with the currently dominant tech giants such as Google and Microsoft, have committed hundreds of billions of dollars of investment in the space.

The fear is that such massive investments in the AI sector will give them an unshakeable advantage in the coming years, and traditional software companies would be left far behind. In India, between 1 January and 20 February, even as the benchmark Nifty 50 declined about 2%, the Nifty IT Index, comprising IT companies such as Wipro, Infosys, and Tata Consultancy Services (TCS), among others, fell about 16%.

The IT selloff has been global in nature. Markets see software services companies as under serious threat from AI tools. For instance, earlier in January, Anthropic released Claude CoWork, specifically aimed at doing tasks within sectors such as legal, sending stocks of companies making legal software into a tailspin. Since CoWork is customized towards low-end work in more and more sectors, legacy software companies face deep uncertainty.

According to Bloomberg, Goldman Sachs recently released a ‘pair’ trade basket of stocks split into two sets. One, a set of stocks to buy, of companies whose work is relatively difficult to replace by AI (Cloudflare, Oracle and Microsoft, among others). Two, a set of stocks to sell, of companies that face a much more immediate threat from AI (Salesforce and Duolingo, among others), underscoring the divide that AI is creating.

In the US, the re-pricing of legacy software companies is not new. It’s a process that began towards the end of 2021, as evident from the trajectory of movement in two sub-indices of the S&P 500, the main barometer of US equity markets. One sub-index is the tech sub-sector, comprising heavyweights such as Nvidia (at the very centre of the AI boom), along with Microsoft, AMD, and Palantir, among others.

The other is the software and services sub-index, comprising companies in the IT consulting and application software space, among others—precisely the set of companies seen as being under threat from AI. Till 2021, the markets treated companies in the two sub-indices as broadly similar. Since the end of 2021, though, the divergence has been dramatic. Between October 2021 and February 2026, the software services sub-index fell by around 16%.

Over this period, the tech sub-index has risen 82%. Even as the world started to struggle out of covid, investors had already begun pouring money into the then hottest AI bets. The Indian tech landscape is dominated by software services companies. There are no homegrown or home-listed, pure-play AI companies yet. As a result, domestic IT services giants, which rely heavily on a labour-intensive outsourcing model, have seen a re-rating.

The price-to-earnings (PE) ratio of the Nifty IT Index is still rated above that of the benchmark Nifty 50, which comprises companies from several sectors. But the gap has distinctly narrowed. Again, this is not new. Valuations of software sector companies soared post covid, as their revenues and margins improved. But this bump was short-lived. Perhaps, ominously for the software sector, even current valuations are higher than they were between 2015 and 2020, suggesting the ‘re-rating’ process might not be over.

Globally, analysts warn of more pain. Goldman Sachs analysts have compared the current plight of software stocks with that of newspaper industry stocks in the US between 2002 and 2009, when they declined 95% amid a shift to digital. In a 2025 research note, Indian brokerage Motilal Oswal argued that software services companies tend to lag behind cutting-edge technologies. As new technologies prove their usefulness, enterprises start investing in them, and that is when software services companies start incorporating such tech into their offerings.

“Each time a new tech cycle emerges, enterprises tend to delay services spending, fearing that rapid advancements could render early investments obsolete," said the analysts. “This pattern is repeating." The note adds that between FY15 and FY19, operating margins of software companies declined as they pivoted to fixed-price contracts. Hiring was in line with revenue growth, and employee productivity remained flat.

FY21 and FY22 were likely an anomaly, caused by the post-covid boom. And while FY25 and FY26 so far have seen an improvement in average operating margin, it’s an open question in the current environment whether that will continue. With the disruption caused by AI, investors across the globe are more concerned about the future path of margins, rather than their current levels. For employees in the software services industry, the prognosis isn’t good.

Overall headcounts of companies comprising the Nifty IT Index are well above pre-covid levels. While hiring kept pace with revenue growth in those years and after, the uncertainty now is much greater. In its latest reports for the quarter ended December, TCS reported a net reduction of around 30,000 employees. “If the industry is to avoid this fate (of declining margins and flat productivity as seen in the period FY15-19), hiring has to be somewhat decoupled from revenue growth.

This should increase revenue per employee and defend margins," said the Motilal Oswal report. Many large Indian software companies missed the ball on investing in cutting-edge tech, and the subsequent burden is likely to fall on employees. Even if the AI ramifications are overblown, and software services companies eventually catch up with cutting-edge tech and incorporate it in their offerings, they will likely do this at much lower levels of staffing in the future.

Summary

This report covers the latest developments in artificial intelligence. The information presented highlights key changes and updates that are relevant to those following this topic.

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