Analysts cautious on mid, smallcaps; await earnings catch-up

Analysts remain cautious on mid-and-smallcap segments and suggest earnings need to catch up before the stocks start to recover

It has been a rough ride for the Indian equity markets thus far in calendar year 2023 (CY23) as they grappled with recession-related fears, rising interest rates amid sticky inflation and the developments with the Adani group that marred sentiment.

While the S&P BSE Sensex has slipped around 0.3 per cent calendar year till date (CYTD), the pain in the mid-and small-caps has been more profound with both these indices slipping 1.7 per cent and 2.3 per cent, respectively during this period. Analysts remain cautious on these two market segments and suggest earnings need to catch up before the stocks start to recover.

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“The mid-and small-cap stocks had run up sharply over the last couple of years and were overpriced. Post the sell-off, quality stocks will recover first. Though the overall market sentiment remains weak, a sharp fall from hereon is unlikely. We remain positive on the domestic markets in the short-term (till June / July 2023-end) and also on quality small-and midcap stocks. That said, we still suggest around 50 per cent exposure to top 250 stocks (in terms of market-cap ranking) till the overall market sentiment becomes positive,” said G Chokkalingam, founder chief investment officer (CIO) at Equinomics Research.

Besides stocks from the Adani group – Ambuja Cements, Adani Power, Adani Enterprises, Adani Transmission, Adani Green Energy, Adani Total Gas, Adani Ports and Special Economic Zone, Adani Wilmar and ACC that were news-driven and slipped up to 66 per cent in CY23 – Dixon Technologies (India), Tata Teleservices (Maharashtra), JSW Energy, Patanjali Foods and Thyrocare Technologies are among the other prominent losers of CY23 in BSE 500 pack, data show.

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At a broader level, said A K Prabhakar, head of research at IDBI Capital, investors are pulling out money from the markets into safer options such as fixed deposits and bonds, which they feel would be a better bet given the overall market volatility.

“The cost of borrowing is rising for India Inc., which will hurt the mid-and small-cap companies more than their large-cap peers. That apart, mid-and small-caps had run up sharply in the last few years as investors flocked to these two segments. Now, they are correcting due to steep valuations,” Prabhakar explained.

On the other hand, mid-cap information technology stocks have been among the top gainers in CY23. Persistent Systems, Zensar Technologies and KPIT Technologies, for instance, have gained up to 26 per cent thus far in CY23. One97 Communications (parent company of PayTM, CG Power and Industrial Solutions, ABB India and PB Fintech (parent company of Policybazaar) have been the other key gainers, data show.

The underperformance of the mid-and smallcaps, according to Gaurang Shah, senior vice-president, Geojit Financial Services, too, has largely been due to the earnings not catching up to the markets’ expectations. He suggests investors remain selective and buy stocks from these segments only if there is earnings visibility and relatively attractive valuation. Mid-cap infrastructure related companies, especially road construction players, and select stocks of auto ancillary companies are among his preferred investment bets.

“In case of small-caps, earnings have not caught up with expectations and will take quite a while before this happens. Small-caps have gone out of flavour after a dream run in the last one-two years. Investors need to be sector and stock specific as regards mid-caps. Fast moving consumer goods (FMCG), banking, information technology (IT) are likely to do well in the mid-cap space, but investors need to be selective. Earnings will take time to catch-up, especially for the small-cap universe,” Shah said.