The Hindu Business Line : Revisiting the mid-cap space

The mid-cap rally skidded in the May-June market meltdown after the sustained bull run of the past three years. Just before the meltdown, there was a point at which the mid-cap valuations of select stocks across different sectors had run ahead of the large caps. No wonder, the correction, when it happened, turned out to be pretty brutal and across-the-board for the mid- and small-caps.

Between May 10 and June 14, when the Sensex touched the earlier all-time closing high of 12,613 points and a low of 8,929 points, the statistics prove a point on the mid-caps and emerging large-caps languishing relative to the broad market.

We categorise mid-caps as stocks trading with a market capitalisation between Rs 500 crore and Rs 2,000 crore, and emerging large-caps at Rs 2,000-5,000 crore market cap.

Of the 400 stocks with market cap of Rs 150-6,000 crore, 320 shed over 30 per cent in value and 78 stocks shed more than 50 per cent in this period.

Despite the market shooting past the 13,000 mark earlier in the month, over 230 of these 400 stocks are still trading at levels that are at least 10 per cent lower than their earlier peak of May 10, of which 160 stocks are trading 20 per cent lower, 90 of them trading at least 30 per cent lower. Only about 85 stocks are trading higher than their May 10 prices.

In this backdrop, here are a few mid-cap/small-cap recommendations that are largely stock-specific across different sectors (see story below).

These stocks may be appropriate for investors who are looking at a 20 per cent return over a one-year time-frame.

We have used a whole host of financial variables, including computation of cash earnings and free cash-flows, to arrive at the stock picks across different sectors.

Apart from quantitative criteria, we have also kept in mind qualitative factors such as management quality and execution record, to some extent while selecting the stocks.

We are conscious of the possibility of a correction at these levels, if external variables turn negative on the interest rate or crude front. And the possibility that such a correction could hit the mid-cap stocks harder than the large-caps. But, this time around, since the valuation of most large-caps look stretched, relatively speaking, a correction may hit them more than the mid-caps.

However, our confidence in the underlying strength of the market stems from the strong macro-economic fundamentals that can trigger the re-rating among the mid-cap stocks.

Since the FII and mutual fund liquidity that had dried up after the meltdown is slowly coming back, the possibility of mid-cap stocks finding favour among FIIs is fairly high.

In the past, it has been found that FII re-rating has been a strong mover of stocks from the mid-cap to emerging large-cap category.

Since the valuation of large-cap stocks appears stretched, there is a good chance of investors moving down the pecking order in their search for value-cum-growth picks.