Moneycontrol
Feb 08, 2017 05:09 PM IST | Source: Moneycontrol.com

Midcaps near all-time highs: How should you trade them now?

It has been a buoyant start to the year for Indian equities. Strong domestic flows, absence of any major negative surprises in the Budget and a general lack of alternative investment options have overshadowed the worry of demonetisation delaying earnings recovery.

Midcaps near all-time highs: How should you trade them now?

Shweta Mungre
Moneycontrol


It has been a buoyant start to the year for Indian equities. Strong domestic flows, absence of any major negative surprises in the Budget and a general lack of alternative investment options have overshadowed the worry of demonetisation delaying earnings recovery.


While both the headline indices – the BSE Sensex and NSE Nifty - have also clocked healthy gains in the run-up, the star performer has been the midcap index.

Since January 1, the BSE Midcap has risen close to 12 percent, more than the 7 percent rise in the 30-share Sensex. Liquidity surge, and beaten-down valuations after demonetisation, with some stocks shedding 30-40 percent, could have driven investors to them.  


According to Sanjay Mookim, Director, India Equity Strategy at Bank of America Merrill Lynch “domestic liquidity tends to be attracted to smaller companies where people believe they have an edge, where they could generate some sort of an alpha perhaps.”


But it is a tough call on how long the expansion in valuation premium will last. Sanjeev Prasad of Kotak Institutional Equities says it is already getting hard to find quality midcaps with right valuations.

Some non-banking finance companies (albeit with strong business models), for example, are trading at 3-4 times FY18 book value making them more expensive than the likes of HDFC Bank or HDFC.


This applies to other sectors as well. Be it pharmaceutical, information technology companies, industrials, agriculture, or chemical stocks, the valuation gap between quality midcaps and large cap companies has narrowed.

This hints that as the ‘TINA’ (there is no alternative) effect wanes off, investors might be quick to dump midcaps and move on to better bets.

As Mookim puts it, midcap valuations will probably continue to rise up until you see a very strong primary pipeline built.

Primary issuances like real estate investment trust (REIT) and infrastructure investment trust (InvIT), besides the healthy IPO and FPO issues -- lined up this year could, therefore, prove to be the tipping point for midcaps as the supply of equity gets spruced up and valuations in this segment of the market stops re-rating.

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