The outperformance in the small-cap and mid-cap indices took everyone by surprise in 2024, before investors hitched their bandwagon to the tearaway rallies in 2023. However, so far in this year, there is no stopping the SMIDs that are outpacing the benchmarks by a sharp contrast.
The NSE Midcap 100 and Smallcap 100 indices have jumped 27 percent and 26 percent, respectively, so far this year. In comparison, the Nifty 50 has gained around 15 percent during the same time period.
International brokerage Jefferies attributes the outperformance to strong flows in SMID, amid better earnings growth expectations and benefit from margin expansion (as commodity prices softened on-year).
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Valuations bite
After the results of India's general election on June 4th, both the NSE Midcap and NSE Smallcap indices continued their upward momentum, rising by 20 percent and 22 percent respectively, compared to a 14 percent increase in the Nifty 50.
The current price-to-earnings (PE) ratio of the NSE Midcap is trading at a premium of 61 percent and 52 percent relative to the Nifty 50 and NSE Smallcap, respectively.
Additionally, the NSE Midcap and NSE Smallcap are trading at a premium of 37 percent and 27 percent compared to their respective 5-year averages, while the Nifty 50 is up by only 8 percent.
The key drivers of growth in SMIDs are stronger earnings growth and healthy returns on equity.
Between FY21 and FY24, the RoE for NSE Midcap experienced a sharp rebound, increasing by 800 basis points from its FY21 lows, while the RoE for Nifty 50 expanded by 320 basis points during the same period, according to Jefferies.
From FY24 to FY27, the earnings per share for the midcap index is estimated to grow at CAGR of 18 percent, compared to 15 percent for Nifty 50.
DIIs increase shareholding
Over the last five years, from December 2019 to June 2024, the average promoter shareholding in Nifty 50 and NSE Midcap constituents declined by 240 basis points and 260 basis points, respectively.
In contrast, domestic institutional investors significantly increased their shareholding by 460 basis points in Nifty 50 and 380 basis points in NSE Midcap during the same period.
Retail participation also rose, though at a slower pace compared to DIIs, while FII shareholding declined by 120 basis points in Nifty 50 and 100 basis points in NSE Midcap.
During this period of excess valuations amid the sharp-run up in counters, Jefferies suggests a bottom-up investment approach in the SMID space.
Amber Enterprises, V-Guard Industries, and Blue Star are among the stocks Jefferies' 'key picks'. The brokerage also has a 'buy' rating on Crompton Greaves Consumer Electricals, Kajaria Ceramics, Finolex Industries, and Finolex Cables. Kaynes Technology is rated as 'hold' due to its rich valuation, while Whirlpool of India has an 'underperform' call.
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