Bet on Large Caps

Investors in Indian equities were taken aback by the market’s performance in 2018, where more than 50 per cent of the listed companies' universe was down by more than 50 per cent. The broader markets underperformed by a huge margin, even as select large-cap stocks managed to get the key benchmark indices in the green. We can say that the largecaps dominated market's performance in 2018. Will the story repeat itself in 2019 for the large-caps? Or will 2019 be the year of the mid-caps and small-caps? 
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Says Vinay Bogawat, who has been investing in equity markets for last two decades, “As an investment policy, I have always adopted 70:30 ratio in favour of large-caps in my portfolio. I have rarely invested in stocks with market cap less than Rs.1,000 crore and 99 per cent of the stocks in my portfolio have market capitalisation greater than Rs.10,000 crore. So far it has worked for me well. I am going to continue with the same formula for 2019. I expect large-caps to perform in line with the Sensex. I will be happy if my portfolio of large-caps deliver returns in the range of 12 to 15 per cent in the coming year. With GDP growing at the rate that it is growing, I believe large-cap stocks will grow as well. ”

There is a set of investors, though, that believes there is value emerging in the mid-caps and small-caps as of now, post the recent correction. According to Nilay Jain, who is seasoned equity investor “I am bullish on mid-caps and small-caps for the coming year. However, I will still be parking 50 per cent of my money in large-caps, and the rest amount I will be investing in quality mid-caps and small caps”. 

While there is little doubt in the minds of investors that the markets are going to do well in 2019 the key question that remains unanswered is – Will it be the large-caps or the mid-caps that will shine in 2019?

So far in the CY19, we find that the BSE Large-cap index is up by nearly 1 per cent as on February 7, while the BSE Mid-cap index is down by 6 per cent and BSE Small-cap index is down by 8 per cent. So far, it does look like a continuation of the trend from 2018 to 2019. Also, looking at the market moods so far in CY19, it is clear that the market is rallying with the help of narrow list of stocks. 



While large-cap investing may be a good idea, it would be foolish to think that all large-cap stocks are great for investment in the coming year. We find that within the large-cap space, there are several stocks that are struggling to remain in the positive territory even as the Sensex is at a kissing distance of its all-time high. If we consider a basket of 200 stocks that are constituents of the BSE200 index, we find that almost 69 stocks are trading close to their 52-week lows and are within 10 per cent range of their 52-week lows. Only a handful of 49 stocks are trading close to their respective 52-week highs, thereby indicating bullishness.


On a YTD basis, if we consider the performance of large-cap stocks or stocks with market capitalisation of more than Rs.10,000 crore, we find that almost 30 per cent of the stocks with market capitalisation greater than Rs.10,000 crore are trading in the positive zone, whereas 70 per cent of the stocks with market capitalisation greater than Rs.10,000 crore are trading in the red zone.This highlights the poor breadth in the markets in CY19.

The performance is even worse when we consider those stocks with market capitalisation less than Rs.10,000 crore but higher than Rs.1,000 crore.


Jayant Manglik
President, Religare Broking Ltd.

"Investments in quality large-caps have the potential to generate returns of 15-20% CAGR over 3-4 years"

In your view, are the large-cap stocks overvalued?

The Nifty 50 index is currently trading at a trailing PE of 27x, wch gives a sense that the valuations are on the higher side compared to the historical average (average 5-year trailing PE at ~23x). However, it is important to note that the index rally in the last few quarters has largely been driven by select heavyweights, most of which are now commanding premium valuations, especially in the FMCG/consumer discretionary space. But, in the context of their recently reported strong financial performance and healthy growth prospects, many of these can still deliver decent returns over the next few quarters. Besides, there are several quality large-cap companies which are witnessing a temporary slowdown in business, but hold a promising future, and are trading at attractive valuations.

Will large cap stocks outperform mid-caps & small-caps in 2019?

The small-cap and mid-cap space has witnessed significant correction from the peak levels in the last one year, which could be largely attributed to the erstwhile inflated valuations, SEBI’s move w.r.t. the restructuring of MF schemes and the Additional Surveillance Measure (ASM) put in place to weed out suspected manipulation. With this, their valuation premium over large-caps has narrowed significantly. While this decline has brought many quality companies back in the valuation comfort zone, market participants are still largely cautious and hesitant to invest in mid-caps and small-caps even at the current beaten down levels (except in few quality stocks). This makes us believe that the large-caps will have an upper hand in 2019 vis-à-vis the mid-cap and small-cap stocks. Nonetheless, we don’t rule out value buying in select pockets of mid/small-cap companies, which offer strong growth potential. Moreover, it is important to bear in mind that mid-cap and small-cap indices have outperformed the Nifty most of the times on a calendar year basis over the medium to long term.

What sort of returns should investors expect for investing in a large-cap portfolio?

Firstly, it depends on the investment time horizon of an investor. Further, investing at respectable stock valuations is crucial for maximising the returns. Investing for a longer time frame (3-4 years) in quality large-caps would certainly provide stable and better returns. Notably, investing in mid-cap and small-cap companies comes with a higher risk-reward equation, while in large-caps, the returns could be relatively lower, but the margin of safety is higher. Investments in quality large-caps have the potential to generate a return in the range of 15-20% CAGR over 3-4 years.

Raunak Onkar,
Fund Manager, PPFAS Mutual Fund

"It surely helps to focus on individual businesses rather than broad markets"

What is your outlook on markets for 2019?

It is hard to predict, but it surely helps to focus on individual businesses rather than broad markets. The indices are made of a variety of businesses which face different industry cycles.

Based on valuations, how are large-caps placed versus mid-caps and small-caps?

Broadly it has been a good year for some large-caps and a very bad year for small-caps and mid-caps in general. A lot of narrative-based ideas are now testing reality as numbers show up. We prefer to look at individual companies rather than whole categories since it gives a better idea of where value resides.

What are the key risks for facing the large-cap universe at this juncture?

There is always temporary volatility due to events like the elections, etc. But broadly, as valuations catch up, the expectations for future growth will become priced in and, in some cases, might exceed the actual growth expectations. It will become important to be very discerning about picking companies that can sustain these expectations.

Is there any evidence that suggests over the long term, the large caps outperform mid-caps or otherwise?

In hindsight, it is easy to justify a trend, however, it may not be wise to generalise it. There can be many reasons for entire market cap segments getting re-rated over a cycle. Some can be earnings-based, some can be based on liquidity-driven momentum or any other reason which we may not be able to figure out. The important thing is when we build a portfolio, it should be based on individual businesses diversified across different sectors, geographies, market cap sizes to take advantage of growth and low valuations in each case. If one has to buy index funds across market cap category, a portfolio approach should work here too since no one can know in advance which market cap index will perform better or worse.

Ravi Sundar Muthukrishnan
Head – Institutional Equity Research, Elara Capital

"We recommend increasing allocation to quality large-caps"

What are you recommending investors on large-cap stocks?

We are in an environment where global uncertainties (trade war unabated, geopolitical issues lingering) are increasing, global growth is slowing. Domestically too, we are now entering an active political phase. Given the above, we expect market volatility to remain enhanced in the months preceding the general elections. Our analysis shows that during periods of uncertainty, quality stocks tend to outperform. Accordingly, we recommend increasing allocation to quality large-caps.

What sort of growth are you expecting in the set of large-cap stocks that you track?

The growth for this quarter is little below our expectation, largely due to macro play of crude and currency. OMCs are taking large inventory losses and we have below operating line deviations in IT sector too. Additionally, auto and metals had a bad quarter. Looking ahead, Q4 will likely be healthy on the back of (a) easing crude, (b) NPL recovery and credit quality improvement (corporate banks), (c) consumption impact of budget and election spending stimuli (consumer- staples/ durables and 2-wheelers).

What is your outlook on markets for 2019?

In CY19, we expect (a) the guessing game of general election outcome to enhance market volatility in the first half; (b) mid-caps to outperform large-caps due to attractive valuations and margin expansion opportunities; (c) dollar index to weaken (monetary easing by US Fed as per market expectation amidst slowdown) and FPI flows to return to India, which is relatively attractive to other EMs; (d) uptick in financial savings to sustain in CY19 due to low returns from other asset classes. We have Nifty target of 12,000 by Dec’19.

Why invest in Large Caps?

• It is said that in the markets, return of capital is more important than return on capital. Large-caps provide the necessary stability to the portfolio, while also delivering steady returns, including high dividend payouts. This is because large-cap companies have a well-established reputation among their consumers and risk of insolvency is generally low .In short large-caps are safe bets when compared to small-caps and mid-caps.

• Large cap companies are run by experienced managements with demonstrated track record of tackling different business cycles and these companies have sufficient data in the public domain for performance evaluation.

• Large caps delivered positive returns in 2018, despite the mid-caps and small caps reporting higher growth numbers (earnings) clearly indicating that large-caps delivered excellent returns on a risk-adjusted basis versus mid-caps and small caps. On risk-adjusted basis, large caps do provide comparable returns with mid-caps and small-caps over the long term.

• Large-cap stocks are easy to research as there is data and history available to research the stock. With research, investors gain more confidence in the stock and long-term investors get attracted to such counters. Institutional players invest only after thoroughly researching the stocks. Thus, large caps attract more smart money and hence are more liquid as well.



Vineeta Sharma,
Head of Research, Narnolia Financial Advisors

"We recommend investors to buy/hold large-cap stocks"

What are you recommending investors on large-cap stocks?

As volatility concerns looms on account of upcoming domestic elections and ongoing global trade tensions, we recommend investors to buy/hold large-cap stocks. The large-cap stocks for the last 2-3 quarters are reporting better sales and net profit growth over the mid-caps and small-caps. Though the valuation gap between large-caps and mid-caps has lowered, the growth in mid-caps have to first catch up and show sustainability before they start demanding a premium valuation once again.

What sort of growth are you expecting in the set of large-cap stocks that you track?

The sales of our coverage universe companies (159) are expected to grow 14%, while net profits are expected to report 11% Y-o-Y growth. For companies which have declared results till now, only 7% of companies reported sales below expectations. The average sales have grown 19 percent and net profits have grown 15 percent. There has been a marked deterioration in EBITDA margins of companies as it grew by a mere 12 percent for these companies.

What is your outlook on markets for 2019?

Post large sell-off in October 2018, Indian equity market has largely remained sideways. Underperformance of mid-cap and small-cap stocks has also softened. At the same time, the broader economy both domestically and globally has gone through a massive change. In this context, how the earnings will emerge for broader indices holds the key for market movement. Our 2019 year-end target for Nifty is 11,800, 19x FY20 EPS. At cap and theme levels, we expect very similar price returns by year-end unlike in the immediate past. Though in the near term, we expect IT and corporate banks to outperform, while automobiles and energy to underperform the broader indices.

Conclusion

Looks like the year 2019 is going to be yet another year where stock picking is going to be extremely important and yet difficult task. The chances of a broadbased market rally at least in the first-half of 2019 is very low. Investors ought not to take their chances when the market is punishing everything that shows weakness. Building a portfolio dominated by quality large-caps having good earnings visibility sounds like a market beating idea at this juncture. With the change in stance by the RBI from hawkish to neutral, the rate sensitive stocks, viz., auto and financials should do well hereon.

Large-cap investing is all about steady investing and one must keep a higher exposure in the portfolio to large-caps at any given point of time. Given the reluctance to invest in mid-caps and small-caps at this juncture. The GDP growth of 7 per cent per annum should not be taken lightly by investors. If you assume the same GDP growth being sustained in the coming five years, what we are looking at is a growth in aggregate demand in the economy by more than 40 per cent, which is huge. Large-cap stocks are bound to reflect similar growth in their businesses. Therefore, sticking with large-caps looks like a good idea for the coming five years if one wants to play it safe with less risk at hand.

Methodology

We bring to you the 250 large-cap stocks which have the highest market cap, sales and net profit. We have used two parameters of financial performance - sales and net profit - to draw up the list of companies with the highest sales and net profit. To evaluate on the basis of market data, we have used market capitalisation as the third parameter. Also, when we talk about large-caps, dividend is an important factor to consider. We have rebased the dividends paid by the companies on the FV of 10 so as to equate the parameter for measuring the returns to the investors. We have then assigned equal weightage to these four parameters to obtain the list of top 250 large cap companies. Please note that we have evaluated the companies based on the market data and financials of companies available in January 2019 .

(All data sourced from : Ace Equity)

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