Mid-Caps To Shine In 2021 But Cautious Optimism Advised!

Mid-Caps To Shine In 2021 But Cautious Optimism Advised!

After underperforming for several quarters, the mid-caps are finally back and for the first time in recent history analysts are taking a clarion call on mid-caps and betting on broader markets outperforming the Nifty. Ganesh Vaybase takes into account the key triggers working in favour of mid-caps while also highlighting the historical performance of this category in recent years. Additionally, the DSIJ Research Team has provided a list of top mid-caps based on certain parameters that will help investors zero in on mid-cap stock selection for their portfolio



The markets have surprised on the upside with the Sensex touching record highs in November and Dow Jones Industrial Average crossing 30,000 for the first time ever in the same month. The story gets exciting because the bulls, many market experts believe, have not tired yet and there is a long way to go ahead – on the upside. Technically, there could be a pause in the near term in the rally and the market may consolidate a bit but there is no doubt that the trading range in the market is expected to move higher even if there may be no breakout seen at current market levels. The key to the market is liquidity. Unless and until the liquidity does not dry up, the current market rally will always have some fluidity.

India has been one of the better performing indices globally and especially in the emerging market space The Indian market has been exhibiting a good amount of relative strength in spite of witnessing one of the strictest lockdowns in the world. If we consider the Top 1,000 companies by market capitalisation, excluding banks and telecom, the Indian equities have reflected best margin expansion when compared with Asian market peers and the emerging market peers. One of the reasons that many investors forget why Indian equity is doing so well is the expansion in profit margins and improvement in productivity and efficiency apart from the gush of liquidity that is pushing the stock prices higher.

Providing a market perspective, Deepak Jasani, Head of Retail Research, HDFC Securities, says, “When one looks at the current market valuations based on historical precedence, the market looks overvalued or is close to it on an index basis. However, this is the outcome of polarisation of the market, targeted FPI flows and big-getting-bigger syndrome seen lately not just in India but across the globe. The Nifty is currently trading at a one-year forward PE multiple of about 27 times compared with its 10-year average of 17-18 times. The levels of PEs have been lifted across the globe over the past few years, driven by rising liquidity and falling interest rates. So even though the current PE seems higher than the 10-year average, it is not very far from the five-year average.”

“Markets discount the future; however, the gush or absence of liquidity could pull it up or be less than what it deserves to be. Post the US elections, emerging economies should come back in favour once the pandemic comes under control. Having said this, large fresh investments at these valuations may be avoided as a technical or fundamentals-led correction may not be far. Also, asset allocation review and the consequent partial shift from equities to other asset classes may be done to adhere to the originally thought allocation plan,” he adds.

Commenting about the broader markets, he states, “The mid and small-cap stocks suffered post 2017 due to the SEBI circular on categorisation and rationalisation of MF schemes. Later, a lot of these companies came under pressure due to disruption, liquidity crunch, technology changes, etc. However, the underperformance of some of these stocks has started to reverse over the last few weeks. This is partly led by encouraging Q2 results. Small and mid-cap stocks will continue to be screened by analysts and investors for building wealth. However, despite a large universe of listed stocks, only a few hundred stocks will be actively tracked from this perspective. In the present disruptive world, business models of most companies have come under threat.”

“Commitment of promoters for the long haul and their skill in adapting to changing times is crucial. In a world where regulatory compliance is becoming tougher by the day, large companies are becoming larger and the smaller ones are getting eliminated. Mid-caps as an index may look fairly valued, but the Mid-Cap index EPS calculation includes a lot of loss-making or low profit-making companies. Hence, the index EPS may not always give the right picture. Also, the earnings’ growth of mid-caps is typically faster than the large-caps due to their low base. Hence, in a normal market they deserve valuation that is higher than that of large-cap indices,” he adds.

While the RBI governor continues to say that economic recovery is sharper than previously expected, the fact of the matter is that we still are in the recovery mode and the disconnect between the stock prices and economic growth at least in the near term is quite wide. The markets are factoring in a V-shaped recovery and the expectation of V-shaped recovery is creating a positive sentiment for mid-cap stocks, leading to a robust outlook for the set of stocks expected to deliver above average returns.

Relative Underperformance

One of the reasons behind strong performance in the broader markets is its underperformance over the past several years.

If we look at the values in the table we find that on an YTD and one-year basis the broader markets have shown underperformance; else, over a period of three to five years the broader markets have shown underperformance. The mid-caps in Indian markets have underperformed not only with relation to its large-cap peers in the local markets but have also underperformed compared to its global peers i.e. US mid-caps and European mid-caps. However, the mid-caps in Indian markets have outperformed the emerging market peers over a longer horizon. The US mid-caps and European mid-caps have delivered the best returns across time horizons.

Nirali Shah
enior Research Analyst, Samco Securities

India’s benchmark index crossed the monumental 13,000 level for the first time ever on the back of buoyant sentiments. Wall Street too in agreement with domestic behaviour steered through its latest milestone of 30,000 in Dow for the first time this week. Across the globe, market participants were revitalised by the improvement in the development of corona virus vaccines and the announcement that the transition of power to US President-Elect Joe Biden is finally commencing. Back home, the markets witnessed their biggest monthly inflows from FPIs of USD 6.7 billion MTD, making India the third most preferred investment destination in Asia after Japan and Korea.

By inspecting monthly FPI flows for this year, it can be observed that FPIs frantically sold equities to the net tune of `65,817 crore in March which marked the market’s bottom. November saw contrary behaviour with FPIs pumping in over `57,500 crore in Indian equities when the markets are at an all-time high. Given the massive amount of FPI inflows, market participants should surely rejoice; however, it is time to be cautious too since the current liquidity and optimism-led rally is majorly driven by market sentiments. And during such a mad chase for momentum, investors often disregard fundamentals. Taking a holistic view on FPIs and DIIs, it can be said that liquidity can still take markets higher; albeit any unpleasant event can cause corrections in the bourses. Risk and reward are unfavourable for both traders and investors currently.

 
 

Conclusion

The momentum is clearly with the broader markets right now with Nifty Mid-Cap and Nifty Small-Cap recording the best November in history. Such euphoria is justified by relative underperformance over three to five years, higher growth and the gush of liquidity present at the moment. As the economy recovers and gets more broad-based, the mid-cap universe stands to benefit the most. How fast and broad-based the recovery will be is also dependent on how well as a nation we are able to contain the spread of the pandemic. Having said that, with inflation on rise there is little hope for further rate cut and hence that support for equity in terms of further lowering rates may not be there in 2021. Also, the liquidity may dry a little bit from the overseas’ investors which may not help stock prices inch upwards.

While there is no negative sentiment in the markets it could be the lack of fresh positive triggers, liquidity pressure, RBI policy decisions, rising corona virus cases and below estimate earnings in the coming quarters that may push equity prices lower. The upcoming quarterly earnings’ report will be watched closely by the investors as it will reflect whether the improved profit margins, productivity and efficiency are sustainable. The rise in crude oil prices may play spoilsport for several mid-caps. One should pay attention to oil prices. While investing in mid-caps is the flavour of the season it is easy to get overconfident. When people around you are overconfident it is easy to get trapped in the same emotional state.

The same can happen while investing in mid-caps. Without being overconfident and overly optimistic, one must adopt a bottom-up investing approach in picking mid-caps. A diversified portfolio of mid-caps with the stocks selected meticulously for their fundamentals and quality of earnings may outperform the key benchmark indices in 2021. There are numerous opportunities in the mid-cap space; however, a cautiously optimistic view on mid-caps is warranted. Mid-caps tend to get extremely volatile at market tops and huge amount of wealth destruction is possible if investors end up investing in mid-caps at tops. Staggered buying in mid-caps is advisable.

Methodology

To come up with a ranked list of mid-cap stocks, we took into consideration five crucial parameters. The first includes market capitalisation. The second and third parameters obtained from the Profit & Loss Account including Sales and Net Profit. We also gave due weightage to variables such as the operating profit and the net profit margin to take into account the profit generated by companies from sales and whether operating costs and overhead costs are being contained. Each parameter was then ranked by awarding it a carefully determined weightage based on its significance.

We then segregated the companies into three categories as follows:

Turnaround Performance: These companies include those that successfully managed to turnaround the losses incurred in FY19 into profits in FY20.

Improving Financials: Although these companies still reported losses in FY20 as they did in FY19, they succeeded in reducing these losses by a notable amount. This indicates that they are on the road to recovery.

Thriving Companies: This list includes all those companies that have seen their profits increasing on yearly basis in FY20. A consolidated ranking was done in each category to arrive at the list.

All the raw financial data is sourced from Ace Equity.

To download  data bank of Mid-Caps Companies 2020 Click Here 

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