Feb 16, 2017 09:48 AM IST | Source: Moneycontrol.com

As mid-caps turn expensive, are large-caps back in fashion?

The sharp run up in mid-cap stocks has made them relatively costlier as compared to the broad index. Based on valuations the BSE MidCap Index is trading at a historic price-to-earnings (PE) of 37.69 times, which is higher than that of Sensex that trades at 21.76 times.

As mid-caps turn expensive, are large-caps back in fashion?

Himadri Buch
Moneycontrol

Even as the large-cap focussed Sensex is 7 percent away from its all-time peak, the BSE Midcap Index too is shy of its all-time high needing only a gap-up of 3.96 percent. In fact, on a one-year basis, the Sensex has generated an absolute return of 19.5 percent, while the mid-cap indices have generated absolute returns of 32.57 percent. 

The sharp run up in mid-cap stocks has made them relatively costlier as compared to the broader index. Based on valuations the BSE MidCap Index is trading at a historic price-to-earnings (PE) of 37.69 times, higher than Sensex's 21.76 times.

Experts are getting a bit jittery on the mid-cap valuation as the difference in the valuation of BSE Sensex and BSE MidCap index is in an overbought zone. Such outperformance of midcap indices lasted for a short span of time in the past. But this time around, the stellar show is lasting for a longer time.

There are several reasons for this disparity. Stocks comprising the midcap space are generally domestic plays, while stocks in the large-cap basket are global players with exports accounting for a significant portion of their sales. With a global slowdown investors piled on midcap stocks where probability of growth was higher.

Indian investors continue to pour more money into the stocks that have generated good returns. Mutual fund schemes have also followed a similar trend. Since the mid-cap schemes are faring well, there is greater inflow of money into these funds. The buying support from mid-cap dedicated funds is supporting the segment from falling right now. 

Though this may sound like a virtuous cycle, experts warn that it may not last for long. It is time to be cautious over this segment, given the expensive valuations of mid-caps.

"At current valuations, we believe that mid-cap stocks are relatively expensive,” said Gopal Agrawal, Chief Investment Officer, Mirae Asset Mutual Fund.

With the risks increasing in this space, experts are advising investors to take a break from their mid-cap addiction.

According to Gautam Duggad, Head-Research, Institutional Equities at Motilal Oswal Financial Services, "Valuations (of mid cap companies) are not in our favour from the last 2-3 years. Mid-cap premium to large cap has expanded.”

"Our analysis suggests that that mid-cap valuation premium that we track vs large-cap, the premium was 3 percent in December. In the beginning of this year that is first month of the year it has gone up to 12 percent. The mid-cap premium to large cap premium has lasted far longer than in the past,” he added.

Mirroring Duggad’s view, Jimmy Patel, CEO of Quantum Mutual Fund added, “Mid-caps are rising due to re-rating of their price-to-earnings multiples and change in ownership.”

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