Book profits in mid and small-cap stocks

Analysts say that many are in the bubble zone and could correct sharply

Of late, investment advisor G Chokkalingam is finding it difficult to come up with fresh ideas for his client in mid- and small-cap space these days. He thinks that the mid- and small-cap stocks are in bubble territory as the valuations don’t justify the price.

“Historically, there would be certain sectors or themes that would trade at stretched valuations and they would lift the entire mid- and small-cap indices. This is the first time I am seeing overvaluations across the board,” says Chokkalingam. He now recommends clients to hold 50 per cent large-caps, 30 per cent smaller companies and the remaining in cash in their portfolio. Until last year, he advised clients to have 80 per cent exposure to mid- and small-cap stocks.

Investment managers suggest that investors should book profit in mid- and small-cap stocks where they feel valuations are already stretched. “For those who want to sit on cash and wait for an opportunity, they should start selling slowly. But if they have an alternative idea to invest in, they can move out expensive stocks entirely,” suggest Prateek Agrawal, business head and chief investment officer, ASK Investment Managers. Some suggest that investors should look at large-caps now. If small- and mid-caps stocks start correcting stocks of smaller companies will fall much faster. The downside will be lower if they are in large-cap stocks.

“Investors need to be very selective if they wish to continue to invest in smaller companies,” says Yogesh Nagaonkar, fund manager, Bonanza Portfolio Management Services. He suggests that investor should look at individual companies, its competitive advantage and then the sector rather than the other way round. He feels there’s still attractively valued companies in plastics, forging and construction.

For mutual fund investors, the core of the portfolio always needs to be diversified funds. The exposure to mid- and small-cap funds should be restricted to 30-40 per cent of the equity portfolio. They should continue their systematic investment plans not worrying about the market valuations and fund managers will take suitable calls on their behalf.

Recently, Kotak Institutional Equities came with a report that said: “We find valuations of several mid-cap. stocks in our coverage universe very high. In fact, it would not be wrong to say that some are in the bubble phase with the market extrapolating strong growth and high returns in perpetuity.” The brokerage feels that some companies do have certain strengths but their valuations are absurdly high especially those in semi-branded (semi-commodity) space. The report gives a list of 19 stocks including in the segment including Amara Raja Batteries, Dalmia Bharat, Shree Cement, Crompton Greaves Consumer, Cera Sanitaryware, Greenply Industries, Voltas and Whirlpool.

Investment managers feel that there is a bubble because to justify the current prices, these companies will need to grow their earnings multiple times in the next two years. But with economic growth, industrial production and credit growth stagnant, it doesn’t seem possible. In fact, DSP Blackrock stopped taking fresh inflows in one of its best-performing funds DSP Blackrock Microcap Fund after the sharp run-up in mid and small-cap shares.

Experts say that smaller companies continue to lure investors as many believe that stock markets are poised for a bull run. Many believe that Bhartiya Janta Party will be re-elected at the Centre in the next general elections after its victory in Uttar Pradesh. The expectation of a stable government is giving hopes to many investors.

 Outperformance may not sustain