Moneycontrol
Last Updated : Mar 11, 2019 01:47 PM IST | Source: Moneycontrol.com

Value buys: Motilal Oswal prefers 15 stocks among beaten-down midcaps

Gautam Duggad of Motilal Oswal also said historical peak-to-bottom correction trends suggest midcap correction is overdone.

Moneycontrol News @moneycontrolcom

Value buying interest, suddenly, emerged in equity market from February 19 and one of the major reasons for the revival in sentiment was strong demand for midcaps & smallcaps.

Broadly, the Nifty Midcap and Smallcap indices continued to underperform benchmark indices since 2018, falling 18 percent and 30 percent, respectively. On the contrary, the Nifty50 gained nearly 5 percent.

"This relentless underperformance of midcaps can largely be attributed to their unsustainable valuation premium to largecaps, macro headwinds, concerns about governance/liquidity issues, and the lack of pick-up in earnings growth," Motilal Oswal said.

Now, most analysts are convinced that given expected strong earnings in FY20 (obviously on low base), benign interest rates & crude oil prices and gradual expected end to asset quality concerns, mid and smallcap companies will perform far better than largecaps in next couple of years, though there could be intermittent correction.

"Market's current behaviour seems to be indicating the beginning of its first leg in the bull market. Massive buying emerged in small and midcap stocks which spilled over to largecaps which indicates that green shoots of the bull market are slowly visible," Jimeet Modi, Founder & CEO at SAMCO Securities & StockNote told Moneycontrol.

Gautam Duggad of Motilal Oswal also said historical peak-to-bottom correction trends suggest midcap correction is overdone.

"The average difference in peak-to-bottom correction between the Midcap 100 and the Nifty in the past has been around 10-15 percent. In the current episode, this difference stands at 23 percent, almost 2x of the average differential," he explained.

Meaningful correction in midcap valuations is one of the major reasons (considering likely growth revival) that explains the rally is expected to continue as valuations turned attractive.

Midcaps had a stellar run in CY17. Notably, the Nifty mid-and small-cap indices delivered 47 percent and 57 percent returns, respectively, versus the Nifty's 29 percent return in that year.

As a consequence, P/E valuation premium of midcaps versus largecaps reached 46 percent in March 2018. However, after the correction in midcaps, the P/E premium now stands at 10 percent.

"Looking at the mid-cap valuations through the prism of the gap between earnings and bond yield suggests that the midcap yield is attractive compared to the recent past (highest in two years)," Duggad said.

Another reason for likely midcap recovery highlighted by Duggad is largecap versus midcap rolling differential returns.

He said analysis of the historical differential of the trailing returns of the Nifty and the Midcap index throws an interesting insight.

"Typically, the spread between largecap and midcap returns has peaked out at 15-20 percent. Post hitting this peak range, the performance has typically reversed in the past. Currently, this spread stands at 18 percent," he explained.

Most experts feel earnings is expected to be major driver for the rally going ahead, especially after a volatile ride over FY12-18.

In FY18, drag from the PSU banks in the midcap index impacted the broader performance of Motilal Oswal universe of stocks.

However, given the rebound in the asset quality metrics of PSU banks and the consequent reduction in provisioning costs, the profits for this index are expected to recover significantly in FY19 with 91 percent YoY growth, Duggad said, adding return ratios are also expected to normalise over the next two years.

In the near term, he said the market direction would be a function of the general elections and the consequent political outcome. "Until then, it will be an era of high volatility."

However, as he believes that the broad underperformance of the midcaps is overdone and interesting bottom-up opportunities are now available in this space across sectors, he presented top 15 preferred midcap bets.

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First Published on Mar 11, 2019 01:47 pm
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