Mid, SmallCap indices slip up to 3% on May 7; analysts cite rich valuations

On Tuesday, the broader indices underperformed the benchmarks dropping up to 3 per cent on the BSE. The smallcaps index was down 2.4 per cent while the midcap index slid by 2.8 per cent intraday on Tuesday. In comparison the S&P BSE Sensex fell by 0.79 per cent, while the Nifty 50 was down by 0.89 per cent. 

Among midcaps Lupin fell 6.58 per cent at Rs 1569 as the pharma major missed street expectations in its January-March quarter earnings. Others such as Aurobindo Pharma, Torrent Power, Ipca labs, Bank of India and Union Bank among others fell in the range of 4 to 5  per cent in intraday deals. 

Shares of companies such as Inox Wind, Rainbow Children's Hospital and Prestige Group fell between 7-8 per cent each among smallcaps. 

Among the reasons for Tuesday’s fall could be a limited upgrade in earnings against elevated market expectations and rich valuations, with investors using this as an opportunity for profit booking, said analysts. 

Those at Kotak Institutional equities believe that the Indian market continues to trade at expensive levels, relative to history and bond yields. Nifty-50 valuations are a lot more palatable though, they say. 

The broader market valuations are even more expensive, with the expensiveness being inversely proportional to capitalisation, quality and risk. Some are unhinged from fundamentals and reality, and entirely based on optimistic assumptions, wrong valuation methodologies and unrealistic narratives, analysts said. 

“In our view, assessing businesses on a bottom-up basis, in light of their business models, gives a better picture on the relative exuberance currently exhibited by narrative-based stocks,” Sanjeev Prasad, Anindya Bhowmik, and Sunita Baldawa of Kotak Institutional Equities wrote in a report. 

Chokkalingam G, founder of Equinomics Research furthers the overvaluation argument by calling SmallCaps valuations 'highly stretched', according to him historically, every time the rally has extended beyond two or three years there is a correction based on the logical foundation of relative valuation compared to large caps. "Presently, smallcaps are trading at higher valuations than their large cap peers,” he said. 

Presently Nifty SmallCap index is trading at price to earnings multiple of 28.2 as against Nifty 50 at 21.8, shows data. 

Another reason is the continuous selling by FIIs, added Chokkalingam as historically they do not take aggressive positions before general elections. He advises investors to avoid buying the dips in the small cap segment at the moment and wait for the return of FIIs sentiment in the markets.