Mid, smallcaps trip on BSE circular, what should be your strategy now?

The mid and smallcap stocks have witnessed some panic selling after BSE introduced new surveillance rules called the ‘Add-on Price Band Framework’ on August 9.

Under this framework, certain securities would be subjected to weekly, monthly and quarterly price limits in addition to their daily price bands.

The exchange, however, on August 11 clarified on framework will apply to BSE-exclusive securities in groups X, XT, Z, ZP, ZY and Y.

Moreover, the securities should have a price of Rs 10 and more as on the review date and the market capitalisation of the security should be less than Rs 1,000 crore.

This clarification seems to have comforted the market as the mid and smallcap indices turned green on August 12.

Even before the BSE circular, mid and smallcap space was under pressure in August. However, they continue to outperform the benchmarks in 2021.

As of August 11, the BSE midcap index has gained 27 percent in 2021, while the smallcap index has jumped 43 percent. The Sensex has risen 14 percent and the Nifty gained 16 percent in the year so far.

The Sensex and the Nifty have gained 3.69 percent and 3.29 percent, respectively, in August so far. On the flip side, the BSE midcap and smallcap have lost 1.63 percent and 3.50 percent, respectively.

The BSE midcap index has been in the green since June 2020 on a monthly basis. Since June last year, January was the only month when the smallcap index fell 0.61 percent.

If both indices end in the red in August, they will snap their multi-month winning streak.

Also read: Explained: What is the Add-On Price Band Framework introduced by BSE?

Reasons behind profit-booking

Profit-booking started in the mid and smallcap space due to their rich valuation. The valuation of midcap index was at par with that of the benchmark, while that of the smallcap index shot up. Consequently, a cool-off was expected.

"The outperformance is very large, resulting in frothy valuations across small and midcap stocks. A healthy correction of 5-10 percent augurs well for the market, and would make these segments favourable back again," said Gopal Kavalireddi, Head of Research at FYERS.

However, it is not the mid and smallcaps, even the largecaps have been witnessing bouts of profit-booking. A combination of factors has led to the current selloff in the market.

Concerns over rising inflation, US Fed taper commentary and an influx of IPOs contributed to profit-booking.

The BSE circular on August 9 acted as a catalyst to rapid selloff in mid and smallcaps.

What should you do now?

The concerns over the BSE circular now seem to have subsided. The recent correction has given some comfort on the valuation front also. Analysts and market experts advise buying quality stocks at this juncture.

"Although there is correction because of profit-booking, the fundamentals of companies are intact provided you are invested in good company. In fact, it should be seen as an opportunity to add quality mid & small caps at 20-30 percent discount. This opportunity to average good stocks with patience will be rewarded in the coming 3 – 4 months," said Rahul Sharma, Co-Founder, Equity99.

Kavalireddi said investors should follow the earnings growth and look for stocks that delivered a superior financial performance in Q1FY22. These could be from any market cap segment.

"The bottom line for any investing—short term or long term—should be about earnings growth. Investors have the advantage of evaluating the current financials, make a list of stocks with promising prospects, and invest based on their entry strategy and market conditions," said Kavalireddi.

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