Mid-Caps in a Sweet Spot!

Mid-Caps in a Sweet Spot!

With the Indian benchmark indices turning into world-beating indices once again, investors’ confi-dence in equity as an asset class is at an all-time high along with the BSE Sensex and Nifty 50. The key question that matters now to most investors is about what next and most importantly, will mid-caps and small-caps repeat the performance delivered in the past one year? Yogesh Supekar discusses how the mid-caps have performed so far and highlights the outlook on mid-caps while the DSIJ research teams shares the list of top-ranked mid-cap stocks

While the Indian benchmark indices are making headlines with their superlative performance in 2021 and in the past one year, the mid-caps are being seen as more attractive at this point of time. The recent outperformance of the BSE Mid-Cap index on a weekly basis is what is keeping the bulls focused on the quality mid-caps. The week gone by saw markets make all-time highs with BSE Mid-Cap index trading at all-time highs and BSE Small-Cap index also trading at record highs on a closing basis. The best part of the market rally in the past one month or so is that the quality stocks have rallied and the participation from the broader markets has improved vastly.

The BSE Mid-Cap index, from its highs of January 2018 has fallen by 47 per cent when the markets bottomed out in March 2020. The BSE Small-Cap index in the similar period tumbled by 57 per cent and BSE Sensex managed to drop by ~30 per cent. From the lows of March 2020 the BSE Mid-Cap index recovered by ~157 per cent while BSE Small-Cap index has gained by 216 per cent and BSE Sensex is up by 126 per cent. 

Clearly the recovery has been the sharpest in the small-caps while it has been better in mid-caps when compared to the BSE Sensex.

Says Hitesh Oberoi, a growth investor, “I think mid-caps will outperform and should be the best bet for growth investors. People talk about small-caps but I prefer mid-caps for a simple reason – quality! The quality component and the ability to take heavy positions in mid-caps is what makes me more focused on mid-caps than small-caps. Small-caps are too volatile and often it becomes risky to build positions in small-caps. Mid-caps can offer the best of both worlds – value and growth. Mid-caps can offer better growth than large-caps and at the same time can offer better value than the small-caps.”

“Practically speaking, the basket of mid-cap stocks is also not as huge as small-caps and hence it is relatively easy to identify quality mid-caps. If one focus on the quality parameters such as free cash flows, PEG, ROE, EV/EBITDA and study for consis-tency in the growth in net profits and net sales, one can easily find the right kind of opportunities in the mid-cap space. While large-caps and small-caps must be the part of one’s portfolio, mid-caps in my mind should be given higher weightage than the small-caps. The weightage for mid-caps can be equal to large-caps in the portfolio if you are an aggressive investor with higher risk appetite and your focus is on growth,” he adds.Multiyear breakout was seen in January 2021 and retested in February 2021. Since the breakout, the BSE Mid-Cap index is up by over 33 per cent. On weekly charts the BSE Mid-Cap index has given a breakout from a consolidation range.

The below table shows how the BSE Mid-Cap index has underperformed the BSE Sensex in past three years and in the past five years as well. The BSE Mid-Cap index has outperformed BSE Sensex in 2021 however and even in the past one year. 

The PE ratio has expanded by ~88 per cent for the BSE Mid-Cap index versus 93 per cent for BSE Sensex.

Chart on the weekly chart, there is a formation of Sizable bullish candle in the BSE Midcap index. The weekly ADX (27.15) shows solid strength in trend. The +DMI is much above the ADX and -DMI. Furthermore, the RSI has crossed above the prior swing high.

Conclusion

When it comes to constructing a portfolio that can beat the markets, the trick is always to find stocks which offer better growth and are available at attractive prices. The valuation is always the key to beating the markets. However, in Indian markets the premium is extremely high for the quality stocks immaterial of market capitalization i.e. large-cap, mid-cap or small-cap.

Quality companies across the board fetch a hefty premium and often leave investors wondering whether it is worth buying quality stocks at lofty valuations. If we go by what history tells us, quality matters and sticking to quality acts both as insurance in market meltdowns and as a growth engine when market sentiment turns positive. When it comes to mid-caps these are often perceived to be more volatile than the large-caps and hence the quality aspect becomes even more important while choosing mid-caps. Quality of business, quality of earning and quality of management needs to be examined thoroughly without ignoring the quantum of earning. Mid-caps are basically proven small-caps that have grown consistently. The mid-caps in general have a large balance-sheet size and hence can fund their expansion at a much cheaper rate. Stronger balance-sheet, better cash flow prediction and ability to expand operations more economically are some of the inherent advantages enjoyed by the quality mid-caps companies when compared to the small-caps.

When it comes to comparison with the large-caps the earnings growth can be expected to be much higher on a consistent basis for mid-caps when compared to the large-caps. Thus, quality mid-caps can offer similar risk returns characteristics if not better than the small-caps and large-caps and hence mid-caps should be part of any diversified portfolio. Mid-caps with above industry average gross profit margins, net profit margins and RoE should be scanned for investment purpose. Often the market share grows for such companies or at least these companies are in a position to improve their market share. Tracking the capex cycle can be an extremely fruitful exercise when it comes to mid-caps.

A fine example is how the investors reacted to the expansion plans of Tinplate Company of India. The stocks soared by more than 30 per cent in just two trading sessions post the company’s announcement about its capex plans. The outlook for the market remains strong. The US markets may be concerned about the jobs data; however, the strong profits may put bulls in control as we move forward. The possible rerating of several mid-caps, positive earnings outlook, capex at early stage of expansion, lower interest rates, high liquidity, FPIs money flow and vaccination drive in full swing may keep the mid-caps healthy.

Research 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 remaining param-eters are obtained from the Profit & Loss Account and include Sales, Operating Profit and Net Profit. We also considered the PAT margin for ranking the stocks as it indicates how efficient a company has been in converting the given sales into profits. 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 FY20 into profits in FY21.
• Improving Financials: Although these companies still reported losses in FY21 as they did in FY20, 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 the remaining profitable mid-cap stocks and their financial performance in FY21. A consolidated ranking was done in each category to arrive at the list. All the raw financial data is sourced from Ace Equity and price-related information is as of September 01, 2021.

To download  ' Mid Cap Databank ' Click Here 

 

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