 "Mid-cap outperformance over large-cap continues")
Stocks of mid-sized companies continue to outperform their large-cap peers, with the valuation gap narrowing between the two.
Returns from the BSE mid-cap index have beaten returns from BSE Sensex almost two-thirds of the time so far this year. The monthly returns of the mid-cap index are almost double that of the Sensex.
But some in the market believe that the segment may be getting a bit too frothy and expensive. Analysts said that the rally in the mid-cap sector is fuelled largely by the euphoria in the large-cap segment stocks. Any meaningful change in the companies’ earnings is still a few quarters away, they say.
Mid-cap stocks have given returns of about 45% so far this year as compared to the 27% returns given by the benchmarks, NSE Nifty and S&P BSE Sensex. Some of the stocks in the mid-cap segment have risen over 3 or 4 times, rewarding the small-ticket retail investors with high returns but with high risks.
Valuation gap between the large-cap stocks and their mid-cap peers in the same sector are also gradually reducing, said market participants.
“There is a bubble in most of the mid-cap stocks. With some of them trading at 20 or 30 P/E multiples, they are as costly, in some cases even costlier than some of the leaders in their sectors,” said G Chokkalingam, founder of Equinomics Research and Advisory.
Analysts said that the sharp surge in returns in the mid-cap segment was bringing in more retail investors and savvy high networth investors (HNIs) into the market. But the rally could get difficult to sustain, with valuations going out of hand minus any substantial growth in earnings.
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The mid-cap segment is usually the den of retail investors who look for good value at low prices. But with many of the large-cap stocks close to hitting their foreign investor participation limit or already having hit it, many of the foreign portfolio investors (FPIs) are also increasing their exposure in the mid-cap segment further fuelling the rally.
Investors also need to watch out for low liquidity and high volatility, said Mayuresh Joshi of Angel Broking.
“If the free-float is low, then volatility in such stocks could be humungous. Liquidity in general in these stocks is lower and investors need to keep in mind the impact cost before investing in some of these stocks,” he said.
Analysts said that investors need to exercise caution and not blindly chase returns as it might be a while before earnings in many of these companies catch up with the stock prices. Despite the government’s policy reform announcements, operations on the ground-level are yet to take off. Many stalled projects are yet to receive governmental clearance.
The capex cycle is yet to revive, distribution channels remain weak, gross capital formation is languishing and interest rates are still above comfort-levels, further stalling capital expansion by some of the companies. While a rating upgrade has already happened for many of the companies, analysts believe that any real increase in earnings is still at least three-four quarters away.
“Just because valuations are looking attractive should not be reason enough to start investing in these stocks. Investors should judge on a case-to-case basis, check for promoter-holding, earnings expectation and the free-float of the company among other things before investing,” said Joshi.
Valuations in many of the healthcare and technology sectors are a bit more stretched while those in the banking and infrastructure sector are comparatively cheaper, analysts said.
However, some in the market believe that the upside could be capped going forward as the market euphoria gets contained in the wake of an interest-rate hike in the US and worries of fund outflows in the coming year.
“The outperformance that we saw in the mid-cap segment in 2014 is not expected in 2015. Eventually expectations will get tempered down and we will see some correction in these stocks,” said Sunil Jain, VP-equity research with Nirmal Bang Securities.