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There seems to be no stopping to the gains in midcap counters. Midcap indices touched fresh all-time highs on Thursday amid strong buying by overseas investors and optimism over the good and services tax (GST) bill. The NSE Midcap gained 0.72 per cent to 14,695, extending this month's rally to 6.4 per cent. The Nifty 50 gained 0.25 per cent to 8,666.3, a fresh 15-month high.
Market experts say the gains in the market, particularly in the midcap stocks, is being fuelled by easy foreign institutional investor (FII) buying. FIIs have been net buyers of domestic shares worth over Rs 11,000 crore for 15 consecutive sessions on Thursday. Record low yields in the developed world and talks of further stimulus have created benign liquidity conditions spurring gains in equities.
Lack of further buying options in the large-cap space has prompted FIIs to chase stocks in the midcap space, leading to expansion in their valuations.
"The Nifty midcaps have rallied very sharply. Their P/E premium to Nifty is at a 13-year high and is above levels seen in 2005 - at the start of sharp economic upcycle. Mid-caps - in that sense are already discounting a rapid acceleration of the Indian economy - an assumption that could come under stress in the short term," says Sanjay Mookim, India equity strategist at Bank of America Merrill Lynch.
In last one year, mid-caps have progressively become expensive than large-cap stocks. For instance, at the end of May 2015, NSE Mid-cap 100 index was trading at a trailing 12-months price-to-earnings (P/E) ratio of 21.7 times, lower than Nifty 50 trailing price to earnings multiple of 23.1 times. The valuation began to move in the favour of mid-caps index beginning June 2015 and the mid-cap index is nearly twice as expensive as Nifty 50 on P/E basis.
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Nifty Mid-cap index is currently trading at around 42 times its underlying trailing earnings compared to Nifty 50 trailing P/E of just 23.6 times. The midcap index has rallied over 30 per cent from 2016 lows compared to around 22 per cent gain on the Nifty.
The change in valuation dynamics has made things favorable for largecap stocks once again, which put midcaps in a vulnerable spot.
"Currently, largecaps are attractively valued compared to midcaps and smallcaps. Investors, who want to take exposure to midcap, need to have a long-term view and not a short-term approach," said Mrinal Singh, deputy chief investment officer at ICICI Prudential AMC.
Despite the sharp gains, there are still pocket of opportunities in the midcap space and investors need to have a stock-specific approach, say experts.
"In India it is always been less about midcaps as an asset less and more about the individual stock ideas. As an asset class it does look very richly valued compared to large caps. It's at the top, so I will be cautious. But even now there are some compelling individual stock ideas," says Gautam Chhaochharia, head of research, UBS Securities India.
