Midcaps have better RoE expansion potential, says Jefferies. Which stocks to bet on?

Midcaps stocks have seen sharp earnings per share (EPS) cuts since April 2022 but their return on equity (RoE) growth potential is better than that of the Nifty stocks, foreign brokerage firm Jefferies has said.

At price-to-earnings ratio of 24x, the Nifty midcap 100 index is now trading at 14 percent premium to its last 5-year average and 35 percent premium to its 10-year average.

"Since April 2022, FY23 EPS cuts have been sharper for Nifty Midcap index at -12 percent against -4 percent for Nifty,” Jefferies said in a recent report. This was on the back of steeper cuts in commodity-led stocks such as HPCL, SAIL and Nalco, it said.

The global meltdown in commodity prices, slowdown in demand amid recessionary fears, elevated input costs and imposition of duties by the government of India crippled the performance of commodities in the quarter gone by.

Also Read: Inflationary pressure on input costs shadows healthy revenue growth in Q2

Thus, EPS cuts have continued into FY24 and FY25. "FY24 EPS cuts for the midcap index are higher at -11 percent versus -4 percent for the Nifty. But, despite these cuts, earnings growth in midcaps at 15 percent has outpaced that of the Nifty at 7 percent year-to-date," Jefferies added.

In this backdrop, the brokerage firm believes prospects of RoE expansion seem higher in midcaps at 320 basis points versus that in Nifty at 60 basis points. One basis point is one-hundredth of a percentage point.

Its key "buy" calls include TCI Express, Thermax, Supreme Industries, Crompton Greaves, Dixon Technologies, CMS Info Systems, Aavas Financiers and Devyani International.

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