Brokers now expect mid-caps to fuel next rally

Will the next round in the stock market rally belong to mid-caps or large-caps? Market analysts seem to be a divided lot on this issue with fund managers voting for large-caps and brokers favouring mid-caps.

Over the past three months, even as the Sensex has crossed the dream level of 11K, gaining 20 per cent, a large section of the market, particularly stocks in the mid-cap and small-cap segments have been left behind in this rally.

While the BSE Mid-cap index has lagged with a gain of 17 per cent, the BSE Small-cap index was worse delivering a mere 8 per cent return. In terms of valuations, mid-caps and large-caps are equally expensive.

Based on a trailing 12-month earnings basis, the Sensex trades at 20.84 times earnings while the Mid-cap index trades at 20.13 times earnings. However, brokers are hopeful that things will change given that mid-caps now look attractive.

According to Sumeet Rohra, an analyst from Antique Stock Broking, "Most of the recent rally have been liquidity-driven on account of continuous foreign fund inflows and they look for liquid stocks which constitute essentially the top 200 companies by market capitalisation. However, this trend is expected to reverse and from April onwards, mid-caps are expected to perform well due to attractive valuations. Companies such as Hinduja TMT, ITI, Prime Properties, Pyramid Retail and ABG Shipyard are expected to beat the the Sensex."

Adds Arun Kejriwal, director of KRIS, "Though large-cap stocks have spiked, the man on the street is not happy. He can not afford to buy Siemens, TCS or Bajaj Auto, which are quoting in thousands per share."

If the Indian economy has to grow at over 8 per cent, the performance has to come from a large section of the market. The sterling performance by only few stocks or sector doesn't depict the whole picture. So mid-caps have to perform and the gap between the large and mid-caps has to narrow. However, for buying any stock, investors have to take cue from yearly results."

However, a fund manager from a leading mutual fund having a different view said, "Frontline stocks will continue to gain momentum as they are more liquid and stable. They will hold up well even if the market comes down, and currently the market seems to be on the risky terrain, large-caps look good. Also, big investments can be hedged by investing in derivative instruments which is possible only in large-cap stocks."

He further said, "Interest rates are going up and most mid-sized companies are seeking to fund their growth through aggressive borrowings. As against this, bulk of large-cap firms such as Wipro, Infosys, TCS, HLL, ITC and Hero Honda are sitting on a huge cash pile which makes them less vulnerable to spikes in interest rates."

Smaller companies, which are financially strong and expected to turn in strong earnings growth, may also rise though there are fewer such companies available at attractive valuations.

Another fund manager said, "Limited interest in mid-cap stocks has more to do with liquidity issues. Some stocks of pipe manufacturers and power equipment firms where earnings visibility is strong and valuation are reasonable may see a rise now. Given the valuations of mid-caps more or less equal to large-caps right now, large-caps look better plays."