Midcaps significantly underperformed large-caps in CY’18 - pushing down the valuation premium over large-caps from 30 percent, during the start of CY18 to the current level of -8%.
After burning their fingers in the mid and small-cap space in 2018, most retail investors seem to be hesitant or reluctant to put their money in the broader market now. However, experts feel selling pressure in the mid-cap space seems to be bottoming and we could be heading for a revival.
The S&P BSE Sensex rose about 6 percent in 2018 whereas the S&P BSE Midcap index slipped about 13 percent. In the same year, S&P BSE Small-cap index was down 23 percent.
Towards the close of 2018, in the S&P BSE 500 index, as many as 34 percent of the large-cap stocks gave positive returns, followed by 27 percent from the mid-cap segment, and 14 percent from the small-cap space.
Midcaps are now trading at 8 percent discount to largecaps, which is lower than long-term averages. This sharp underperformance and under ownership could well result in revival in the mid-cap space.
Key reasons leading to significant underperformance for midcaps last year were overvaluation, earnings downgrades, the imposition of long term capital gain tax, and SEBI reclassification of mid-cap and small-cap funds.
“Midcaps significantly underperformed largecaps in CY’18 - pushing down the valuation premium over largecaps, from 30 percent during the start of CY18 to the current level of -8 percent (below long-term average levels),” Elara Capital said in a report.
“We believe midcaps are likely to significantly outperform largecaps this year due to the following reasons: a) Valuation comfort, b) Easing cost pressure due to softer crude oil prices to bump up margin and c) earnings growth,” said the report.
Based on Bloomberg consensus estimates, the one year forward PE of Mid-Cap index has now converged near Nifty PE of ~16x that suggests the froth and overvaluation in the mid-cap space have come off sharply due to the underperformance vis-à-vis Nifty.
Earnings will be the driving factor for the Indian market in 2019 even though we could see some knee jerk reaction post-election outcome. Investors will be better off investing in stocks in large or midcaps that are displaying signs of growth momentum.
“Earnings revival could be the most important driver of the Indian equity market in CY19. We feel there is a very high probability of mid and small-cap stocks outperforming the largecaps in CY19. The scope of valuation re-rating remains very high in a host of mid and smallcaps provided earnings come in line with estimates,” Teena Virmani, Vice President—Research, Kotak Securities said.
“It is ideal to have higher allocation into high earnings growth largecaps and midcaps (with strong management pedigree and reasonable valuations). Post elections, one can increase exposure to beaten down mid and smallcaps if we have a clear mandate or single party-led coalition government is at the centre,” she said.
Where should investors park their money in the mid-cap segment:
Well, there are plenty of stocks that are showing growth momentum based on what brokerage houses are recommending.
Investors should take some time to build their portfolio and don’t exhaust their reserves at once. Instead, stagger your buying on every dip. For an aggressive investor, 40 percent allocation towards mid and small-cap space is a good way to tread volatility and achieve the goal of wealth creation.
“Allocate when markets are spooked and buy high-quality large-caps when the markets look the most stressed. Accumulate mid-caps with more study about the fundamentals. Allocation of 60 percent to largecaps and 40 percent to mid and smallcap for a risk-neutral investor with no immediate cash requirements is advisable,” B Gopkumar, ED & CEO, Reliance Securities told Moneycontrol.
“For a risk-averse investor, investing 80-85 percent in large-cap stocks and 15-16 percent in midcaps is a good framework to build a portfolio for 2019,” he said.
Karvy Stock Broking recommends 10 stocks from their 'value invest' portfolio for the year 2019 that include Bajaj Electricals, Finolex Cables, Jain Irrigation, KPR Mill, Relaxo Footwear, Sunteck Realty, and Take Solutions.
Kotak Institutional Equities recommends 15 stocks from their mid-cap portfolio that includes names like Shriram Transport, Petronet LNG, MindTree, Laurus Lab, Jubilant FoodWorks, Federal Bank, Equitas Holdings, and Escorts among others.
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