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Mid-cap stocks have stolen the show this year, but the Street is turning cautious. This is because valuations of small- and mid-cap stocks compared to large-cap ones are at historic highs. Due to higher risks, mid-cap stocks normally trade at a discount, but the 20 per cent outperformance has meant the valuation premium of large-cap stocks has been eroded.
Ravi Shenoy, assistant vice-president, mid-cap research, Motilal Oswal Securities, said the risk/reward ratio is unfavourable and investors have to be selective. In the mid-cap space, he favours Finolex Industries and Berger Paints. Their valuations are attractive and the growth outlook remains strong. Gautam Chhaochharia and Ruchi Vora of UBS Securities India advise investors to get selective and advocate a bottom-up approach. They advise picking companies with re-rating potential backed by turnround and available at discounts to peers.
While mid-cap stocks are unlikely to outperform large-cap ones in a year, brokerages estimate the Nifty will touch 9,200 in 12 months, a return of 16 per cent from the current levels. Analysts at Bank of America-Merrill Lynch point to the earnings downgrades cycle in the past and say we are now moving to an earning upgrades cycle. As the economy improves, higher capacity utilisation, operational leverage and better pricing power will drive margins and earnings surprises. Also sectors that already have excess capacities and are running at low utilisation could easily see upgrades even if there is a marginal recovery in demand. Automobile, cement and commodities sectors have low utilisation levels. These could see benefits accrue.
Given the expectation of falling interest rates, brokerages are looking at interest-rate sensitives. Analysts at UBS believe interest rates are headed 200 basis points (bps) lower over two years. Falling rates are expected to help high-debt companies on account of lower interest payments. While consumption-related cyclicals such as automobiles will gain due to lower monthly outgo for consumers, leveraged plays such as real estate and industrials will also gain on debt rejig. Finally, financials, being a proxy to the rate cycle, will benefit on the back of a pickup in loans. Morgan Stanley analysts see banks as a structural story, with cyclical tailwinds, and prefer HDFC Bank, Kotak Mahindra Bank and Shriram City Union Finance. Further, with inflation expected to moderate, companies with high food costs such as Britannia could surprise with launches and gross-margin expansion.
On the reforms front, easing of pricing restrictions in the oil and gas space is expected to benefit Bharat Petroleum Corporation Limited and Oil and Natural Gas Corporation.
