With reasonable valuations and robust growth projections, midcap stocks get ready to bask in the spotlight.
The later part of the rally in the market was led by largecap stocks, mainly the index companies. This was among the key reasons for midcaps underperforming in the last one month -- the BSE Midcap index has delivered only 6.6 per cent returns in the last one month vis-a-vis the Sensex’s 11 per cent returns. But, will this continue, and for how long? We spoke to experts, who suggested that the midcap space looked attractive and could deliver better returns though investors would need to be selective.
Time to catch up
“A lot of foreign money has flowed into the largecap space, which is also a reason that midcaps have underperformed in the recent past,” says Satish Ramanathan, a fund manger at Sundaram BNP Paribas.Till September 24 this year, FIIs have invested about Rs 81,800 crore in the Indian markets, which is among the largest inflows in recent years. Also, analysts believe that a lot of this money has come through exchange traded funds (ETF) or index funds, which in turn has been invested in index stocks.
| SELECTIVE APPROACH HOLDS KEY | |||||
| Companies |
PE (x) | EPS CAGR | RoE | Price | |
| FY11E | FY12E | (2010-12) | (%) | in Rs | |
| BGR Energy | 18 | 15 | 34 | 32 | 772 |
| Shree Cement | 9 | 8 | 11 | 36 | 2070 |
| IVRCL | 21 | 17 | 12 | 11 | 170 |
| Voltas | 22 | 16 | 18 | 41 | 245 |
| Sterlite Tech | 13 | 10 | 14 | 32 | 102 |
| Era Infra | 13 | 10 | 44 | 22 | 238 |
| Source: Analysts’ estimates | |||||
Typically, money flows into largecaps first and later into the midcap and smallcap space. However, analysts also say that it does not suggest that midcaps will necessarily perform well going forward. “The money may not flow so fast in the midcap space immediately. However, selectively, good midcap companies with reasonable valuations might see some action in the time to come,” says Karun Mutha, head equity at HSBC InvestDirect.
There are others who sound more optimistic.
“I think the midcaps should catch up in the near term given the underperformance and relatively better valuations. Also, if we look at most of the domestic institutions, they have booked their profits in largecaps and are now sitting on cash. If the markets remain sideways that money will come back — a part of these funds could get allocated to midcaps,” says Suhas Samant, who is a fund manager (PMS) at Sharekhan.
Valuations & earnings
The underperformance of midcap companies compared with their large cap peers has also widened the valuations gap. For instance, the Sensex is currently trading at about 24 times its historical earnings, which in the case of the BSE Midcap Index is less than 20 times. In other words, midcap valuations are at a nearly 20 per cent discount compared with the largecap stocks. In terms of earnings growth, on the back of a revival in the domestic economy and demand, the earnings of midcap companies are expected to grow about 25 per cent over the next two years. Considering that the valuations are at a discount and the earnings are expected to be strong over the next two years, investing in midcaps could be rewarding. Investing in companies that offer a combination of growth visibility and reasonable valuations will be the key differentiator.
Strategy
Most analysts believe that investors should remain in sectors that are levered to economic growth such as capital goods, infrastructure and domestic consumption.
While experts advise keeping some portion of the portfolio in domestic consumption themes such as auto, banking, etc, they suggest that sectors linked to investment (infrastructure, capital goods, etc) should do well. That’s because the consumption story (outperformance) has played out to a large extent and should therefore deliver healthy returns going ahead. But, as demand picks up and companies start scaling up capacities, stocks in the investment-related theme should do better, aided by some rerating.
Infrastructure could be a good space considering that the companies will benefit on account of higher investments in the sector and in many of the midcap companies the order book is almost 3-4 times their revenues, which provides good visibility. This is also true in the case of the capital goods sector, where the companies are expected to do well.
Broadly, India’s medium-term economic growth story continues to remain healthy on account of a revival in demand -- the current year looks particularly good given the better monsoon and its impact on rural demand. Meanwhile, experts also advise that investors should not get carried away by the hoopla around the markets and should carefully scrutinise the fundamentals and valuations before investing in any midcap stock. Adopt a piecemeal approach and spread the eggs across companies and sectors, they say.
