Scales tilt in favour of large stocks

Sensex outperforms MidCap and SmallCap indices from May

Last week’s market crash saw the mid- and small-cap companies bleed more than the large-cap stocks. The fall further widened the recent outperformance of the blue-chip-oriented Sensex over the BSE MidCap and BSE SmallCap indices seen in recent months.

Since May, the Sensex’s returns have been 480 basis points (bps) more than the BSE MidCap index, and 652 bps more than the BSE SmallCap index.

Experts said the outperformance was likely to continue as the markets enter a turbulent phase amid flaring geopolitical tensions between North Korea and the US. Also, large-caps provide more comfort on valuations and visibility, they added.

The BSE MidCap and SmallCap indices have pipped the benchmark Sensex and the Nifty in the past three calendar years. Even on a year-to-date basis, the returns of MidCap and SmallCap indices are still better than the Sensex returns (See table).

However, if the recent trajectory is anything to go by, large-caps are likely to end the year better than the mid- and small-caps after a gap of four years. The trend assumes significance for investors who have to opt for either large-cap- or mid-cap-oriented schemes, while investing in mutual funds. The Sensex’s trailing three-month outperformance over the broad-based MidCap index is the most in over three years.

“In recent months, the action has shifted from broader markets to large-cap stocks. The sharp upward stock movement in a majority of the mid and small-cap companies has happened in the absence of any recovery in the fundamentals of the companies. On the other hand, there are good buying opportunities in large-caps,” said Arindam Chanda, head of broking, IIFL. He added that even valuations of large-caps are comparatively moderate.

The valuation differential between Sensex and smaller stock indices has widened substantially, which tilted the scales in favour of blue-chips, say experts. Thanks to the outperformance in the past three years, the BSE MidCap index trades at a trailing 12-month price-to-earnings (P/E) multiple of 33 times, while the Small-Cap index at 48 times, compared to Sensex’s 23 times, data provided by Bloomberg show. While the Sensex is still some distance away from peak valuations, the P/E multiple for the MidCap and Small-Cap indices are near historical high.

While Sensex, too, is trading above its historical average, analysts say the valuations will normalise, as larger companies are expected to lead the earnings recovery. Recent government reforms such as the goods and services tax and demonetisation are seen as favouring bigger businesses more. “The scenario is changing now as institutional investors are returning to large-caps. It could be a good time to invest in these stocks that have been beaten down. Further, earnings recovery has been better than expected in large-caps, compared to mid-caps,” said Deven Choksey, managing director, KR Choksey Securities.

Mid-cap earnings disappoint

Out of the 196 companies in the broad-based BSE 500 index, which have declared their results for June quarter, 136 companies, or nearly 70 per cent, have failed to meet analysts’ expectations. Around 100 companies posted 15 per cent lower net profit, compared to consensus estimates. The situation in the BSE Small-Cap index is similar, where more than half of the 759 companies have declared their results. Of these, over 50 per cent have failed to meet expectations.

The sharp rally in the market this year, without significant earnings recovery, has stretched the valuations of a lot companies in the small stocks space. As far as the benchmark Sensex and Nifty are concerned, the earnings of the pharma pack have been a drag though the sector’s weight is relatively lower. However, the only headwind for the indices could be its large weight to the financial sector. With the ongoing bankruptcy proceedings, analysts warn the provisioning of large banks could see a steep rise.

Last time the benchmark indices decisively outperformed MidCap and Small-Cap indices was in 2013, when the benchmark Sensex went up 9 per cent, while the MidCap index lost more than 6 per cent and Small-Cap index lost 11 per cent.  Since 2014, mid and smallcaps consistently gave better returns than Sensex.