Why index heavyweights are set to do the heavy lifting

Nitin Bhasin, Head of Institutional Equities at Ambit

The proverbial phrase "when the going gets tough, the tough get going" may finally be taking shape. According to Nitin Bhasin of Ambit Capital, index heavyweights appear poised to outperform the market. This conclusion stems from an analysis of index concentration levels, which are currently at their lowest historical point, indicating a likely return to polarisation in the near future.

Historically, a return to polarisation has typically been accompanied by market declines. Under current circumstances, however, it also implies that heavyweights are likely to outperform. Ouch! Did that feel like a bouncer? Let’s break it down.

Ambit created a metric called the Market Concentration Index, which is the sum of the squares of the weights of all the index constituents—in this case, the NSE 500. The sum of squares measures how far data points deviate from the mean. When applied to market concentration, it shows how much individual stock weights deviate from the average constituent weight. A higher sum of squares indicates greater variability from the mean, and vice versa.

What do high concentration levels indicate?

Historical trends show that markets usually peak when concentration levels bottom out. Currently, Ambit’s analysis reveals that the concentration level for the NSE 500 is at a historic low. This is because the index's rise in recent years has been driven by smaller stocks or those with lower weights in the index. The larger-weighted stocks have underperformed, leading to a more level distribution of weights across the index constituents.

However, from where markets are now, a reversal may be on the horizon—meaning there could be a rise in concentration, or what Ambit analysts call a “return to polarisation.” Polarisation is the opposite of low concentration: it means the weights of various stocks will diverge more. This will occur when the larger-weighted stocks start outperforming while smaller-weighted stocks underperform, further dragging down their index weights.

This shift aligns with fundamentals that show earnings disappointments are relatively low among large-caps, and their earnings sustainability appears stronger.

Why it may be time for heavyweights to rise

From 2014–2019, the top 10 companies drove the bulk of economic profits, leading to increased stock market concentration. Over the last few years, however, economic profits have been driven by the rest of the stock market, leading to significantly decreased concentration.

As the economic environment becomes more challenging, heavyweights are expected to drive earnings growth. Ambit’s research also shows that earnings estimates for large-caps are significantly more sustainable compared to mid-caps and small-caps.

In the current reporting season, companies that have disclosed results so far show Nifty PAT growth at 5.4%, compared to just 0.4% for mid-caps and -3.7% for small-caps. “But it’s not just the headline numbers; earnings downgrades are more widespread in mid-caps than in the Nifty,” notes Bhasin of Ambit. Among mid-caps, 48% of the index constituents saw more than a 5% EPS downgrade, versus 34% for Nifty stocks. Additionally, 32% of mid-cap stocks witnessed upgrades compared to 40% in the Nifty, according to Ambit Capital.

Time to be selective

Further, multiple expansion has been the primary driver of returns in recent quarters as earnings growth slows. “In a deteriorating earnings environment, we believe caution is warranted given the expensive valuations. FY25 is expected to be a stock-picker’s market, so selectivity is key,” adds Bhasin.

Ambit highlights banks as a sector positioned at the intersection of reasonable earnings growth and valuations. The sector is expected to significantly outperform over the next 12 months.

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