Analysts say small stocks could pip big ones this year

Despite their initial underperformance, smaller firms will eventually fare better than marquee companies this year, say brokerages. This could be led by an improvement in fundamental factors, including profitability, on the back of monetary easing by the Reserve Bank of India (RBI).

Last year, the surge in small- and mid-cap stocks was largely fuelled by growing risk appetite among investors.

In its India strategy report, foreign brokerage firm HSBC has identified ‘rotation from large caps to mid-caps’ as one of the themes for 2013. “The valuation gap between mid-caps and large-caps have widened in the past couple of years, as investors have preferred large-caps in an uncertain environment... Though the growth of passive money pools has made a strong case for richer valuations on large-caps, we expect monetary easing to see liquidity percolate into mid-caps,” says HSBC in the report.

However, despite the rate cut in January, investors are yet to shift their focus to the smaller companies. Since January 29, when RBI eased key policy rates by 25 basis points, the BSE Midcap and Smallcap indices declined 3.4 per cent and 6.2 per cent, respectively, while the Sensex fell two per cent.

Analysts said it would be difficult to predict the exact timing of the shift from large-caps to mid-caps but added that during sustained periods of monetary easing, mid-caps tend to outperform.

“The net debt to equity levels for frontline companies is much higher than that for smaller names. When monetary easing does kick in over a period of time, the companies which have higher levels of debt will stand to do better,” said Jitendra Sriram, head of research, HSBC Securities and Capital Markets India. However, Sandip Sabharwal, chief executive officer, portfolio management services, Prabhudas Lilladher, was cautious in his response. “Although the RBI has cut policy rates, it is yet to percolate down. We have to see what happens in the March policy. If there is significant improvement in liquidity conditions in April, then the argument should hold,” he said.

Only a fifth of the stocks in both BSE Midcap and Smallcap indices have given positive returns since the start of 2013. “Mid-caps outperform if there is a sharp upturn in the economy, which is unlikely. In this scenario, it looks difficult that the midcap index will outerperform on a sustained basis, it could be stock-specific outperformance,” said Piyush Garg, EVP and CIO, ICICI Securities.