The Investment Column: IT euphoria is unlikely to last

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The Independent Online
December was a great month for information technology (IT) stocks. When the Stock Exchange announced plans to give Britain's booming IT sector its own index, investors piled in. In five weeks shares in three of the sector's largest constituents - Sema, CMG and Logica - have all risen by more than 15 per cent.

This euphoria looks unlikely to last. After all, the rise is down to investors adjusting their holdings to the sector. Currently a subdivision of the catch-all Support Services group, IT stocks will have their own sector once their combined value is large enough - probably at the end of this year. That means institutional investors need an exposure to the stocks, and judging by the recent scramble most were horribly underweight. The largest, most liquid stocks have enjoyed the biggest rises.

But valuations are looking stretched. CMG currently trades on a multiple of 36 times 1998 earnings, while Sema gets a multiple of 34. FI Group, buoyed by its recent Indian acquisition, is awarded an even more fancy rating. Even taking into account phenomenal growth, fuelled by the millennium bomb and the introduction of a single currency, this looks overdone.

The problem is that IT consultancies' growth is limited by how much staff they can bring in, and recruitment is getting desperate. Schemes to guarantee anyone who passes a degree course a job, or to recruit unskilled workers and train them, may plug the gap for a while. Sooner or later, however, firms will have to start delaying contracts because they can't get the staff. If anything, these pressures will be worse this year than last summer, when staff shortages prompted Logica to issue a profit warning.

Perhaps the software companies like Misys, Sage and Micro Focus offer better value? True, ratings are marginally more modest and growth not so vulnerable to staff factors. Even so, p/e multiples in the mid-20s hardly offer much scope for outperformance.

Bargain-hunting investors may prefer to sniff out some of the sector's smaller constituents, who have seen less of a rise and offer better value. There is also value to be had elsewhere in Support Services, which is one of our favoured sectors for 1998 . But having welcomed the creation of an IT sector, investors should probably now avoid it.