Year-ender 2020 | Mid, smallcaps outplay Sensex, will the winning run continue in 2021?

The record-breaking spree of the Sensex and the Nifty has brought a lot of cheer, and money, to investors but a lot has been happening in the broader mid and small-cap universe too, offering good, or even better, investment opportunities.​

As of December 18 close, the BSE midcap index gained 19 percent and the smallcap index 30 percent in the calendar year 2020, so far, against a 14 percent gain in the Sensex.

Mid and small-caps are yet to touch their 2018 peaks, so there is some steam left in them, analysts say.

The government and the Reserve Bank of India's efforts to boost the economy and a rise in retail demand amid healthy quarterly earnings helped the mid and smallcap stocks to climb up from their March lows.

With the macroeconomic climate looking better, mid and smallcaps may surprise investors in the weeks to come.

India's GDP for the second quarter of FY21 contracted by 7.5 percent, an improvement from a 23.9 percent contraction in the previous quarter. Latest high-frequency macro indicators hint at green shoots amid gradual momentum in demand and consumption from restarting of business activities.

Ashis Biswas, Head of Technical Research, CapitalVia Global Research, said mid and small-cap companies will benefit the most due to lower interest rates.

Moreover, with a rebound in economic activity and an increase in domestic demand, the space is expected to witness further momentum, which is an opportunity for long-term investors, he said.

We believe the valuation gap in this sector after the significant correction is attracting investors to move into midcap stocks.

-Ashis Biswas

The recovery cycle should last six to nine months and their quarterly earnings should improve further after the recent slowdown.

"We have already observed the consumption cycle to revive, and the recovery will continue. It may take a longer time than anticipated to fully restore the damage to mid to small-cap companies but selected stocks are attractive from a valuation point of view," Biswas said.

"We believe the valuation gap in this sector after the significant correction is attracting investors to move into midcap stocks."

With recovery picking pace, markets may see gains across pockets.

The rural economy remains strong due to good monsoon-driven farm incomes. The urban economy will also normalise with the coronavirus vaccine roll-out.

Ashutosh Tiwari, Head of Research, Equirus Securities, said considering the gains in largecaps and as mid and smallcaps are still below their 2018 peaks, the market rally will broaden and therefore mid and small-cap should be the theme to play over the next one year.

Given optimism around the economy, Narendra Solanki, Head- Equity Research (Fundamental), Anand Rathi Shares & Stock Brokers, said mid and small-cap stocks would continue to outperform in 2021 despite rich valuations.

"While markets may witness a bit of a pause before earnings catch up, we believe that quality companies in these segments with market leadership, clean books and good corporate governance should continue to perform," said Solanki.

Decent earnings, continued retail investors’ participation and government measures to boost the economy should also support the segment, he said.

The coronavirus outbreak, however, remains an overhang. A lot will depend on COVID-19 vaccine rollover and how effective it turns out to be in curbing the pandemic. Factoring in such uncertainty, largecaps may still be safer bets than mid and small-caps, say some experts.

Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities, favours largecaps over midcaps.

"Between large and midcaps, we would prefer largecaps as they could be more resilient in any future correction and also remain the favourites of FIIs," he said.

"Since the small-cap space is an ocean one can do individual bottom fishing with proper research and reading," Oza said.

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