News Analysis

Down-and-out mid-cap stocks may be ripe for the picking

Venkatasubramanian K BL Research Bureau | Updated on September 06, 2018 Published on September 02, 2018

SEBI’s move to reclassify mutual funds with specific definitions for mid-caps also seems to have played a role in contributing to the correction in the segment

Some stocks in the segment have fallen by up to 80%

Even as the blue-chip benchmarks Sensex and Nifty – up nearly 20 per cent in the last one year – flirt with new highs, mid- and small-cap indices have had a rather more sedate run, and are up by less than 10 per cent. In fact, individual stocks in the mid-cap space have fared far worse, and are down in some cases up to 80 per cent over the same period.

Does this fall in mid-cap stocks present a buying opportunity? Analysts and fund managers told BusinessLine it does. And although valuations in the mid-cap space are somewhat elevated and some of these stocks are trading at a premium over blue-chips, this is no cause for concern, they reckon.

Says Akash Singhania, Fund Manager, Motilal Oswal AMC, “Mid-caps have seen a healthy correction in the past six months, which has taken the froth off their valuations.”

G Chokkalingam, Founder and MD of Equinomics Research & Advisory, concurs: “This is the right time to start buying mid-cap stocks. Eight out of 10 mid-cap stocks are down anywhere from 15 per cent to 80 per cent. Normally, when mid- and small-caps crash, they take between one and three years to recover. But in the past seven months, the correction in mid-caps has been so severe that the fall is equivalent to what happens over two-three years.”


Large-cap versus mid-caps

Adds Harshad Patwardhan, CIO-Equities, Edelweiss AMC: “Based on historical analysis, it is likely that a large part of the under-performance of mid-caps versus large-caps is behind us.”

The ongoing rally in the Sensex and the Nifty suggests that the overall market is overheated, but this may not be the case. Analysts and fund managers, however, say that the large-cap rally has been fairly narrow, and comparing large-cap indices with mid-cap benchmarks may not present the true underlying picture.

Deepak Jasani, Head of Retail Research, HDFC Securities, observes: “Three stocks − Reliance, Infosys and TCS − have contributed to more than 50 per cent of the rise in the Nifty over the past year. Within mid- or small-cap indices, the situation is similar.”

Chokkalingam adds: “Of the 4,000 actively traded stocks in the market, if we take out the top 15 Nifty stocks over the past one year, the remaining stocks have lost as much as ₹10-lakh crore in market capitalisation from the peak in January.”

Market regulator SEBI’s move to reclassify mutual funds with specific definitions for mid-caps also seems to have played a role in contributing to the correction in the mid-cap space.

Jasani says, “The SEBI circular on mutual fund reclassifications dented small-cap valuations, while for mid-caps, the subsequent changes to the Nifty Midcap-100 Index caused a vast churn among stocks.”

Justifying valuation premium

Despite their fall, mid-cap stocks’ valuations are still high compared to large-caps. In the past, when mid-cap index PE multiples exceeded those of the large-cap index, it invariably signalled a broader market correction. Does the observation hold true now?

Says Patwardhan of Edelweiss AMC, “It is more meaningful to compare large-cap and mid-cap stocks in the same sector. Such a comparison will show that often, mid-caps have sustained higher multiples than large-caps. If the fundamentals justify it, there is no reason why mid-caps cannot trade at a premium to the corresponding large-caps.”

Earnings, too, are expected to be better for mid-caps, and the valuations may not be stretched.

As Akash of Motilal Oswal notes, “In the financial year ending March 2019, mid-caps are expected to post an earnings growth of 30 per cent, against a decline of 20 per cent in FY18. Going forward, on a price-to-earnings ratio basis, mid-caps may continue to trade at a premium to large-caps, given their higher growth prospects. However on a PEG (Price earnings – Growth) basis, the valuation of mid-caps is almost on a par with large caps, with both being close to 1 on a one-year forward basis.”

Published on September 02, 2018
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