250 Mid-Company

After several years, the narrative in stock market has shifted from 'bottoms up' approach of stock selection to the slowing economy and the broad based underperformance of the markets. Surely, the pain and problems are not restricted to the mid-caps—the problems are much more universal this time around. Indeed, factors such as the slowing economy, US-China trade war impact and liquidity crunch are making the headlines and impacting the way investors analyse the markets. While the sentiment is negative for the markets and even more so for the mid-cap stocks, the fact remains that the mid-cap stocks are more attractive today than six months ago or even one year ago. But that does not mean the mid-cap stocks have bottomed out yet.

Analysts are busy downgrading targets for individual stocks and some of the biggest investment advisory firms are revising the year-end target for Sensex—downwards. Investors are struggling to protect their portfolio returns and experts are clueless as to which sectors will outperform. It is a perfect combination of factors that hint at the peaking pessimism. 

It is exactly in environment such as today's that one has to build a portfolio of stocks that will deliver in three to five-year investment horizon. Says Mustafa Nadeem, CEO, Epic Research, “What we are seeing in prices is a correction that was overdue, and which is part and parcel of a trend”.

We may be in the midst of a bearish trend for the mid-cap stocks right now. This bearish trend has been in existence for almost over 18 months. About 50 per cent or more than 100 mid-cap stocks out of the 200 mid-cap stocks (as defined by SEBI as per market capitalisation) are trading in the range of 20 per cent from their 52-week lows. A mere 57 stocks are trading in the range of 20 per cent from their respective 52-week highs and as low as 24 stocks are trading in the 10 per cent range of their 52-week highs. This goes to show the pain in the mid-cap space and the extent of damage the mid-caps have suffered over the past one-and-half year.

Says Sudarshan Raut, who is a small-time mid-cap investor, “I have 30 stocks in my portfolio, out of which at least 20 stocks are mid-cap stocks. 15 out of these 20 stocks are close to their 52-w lows. I am stuck with these underperforming mid-cap stocks. Can’t sell, nor do I want to average in them”.

Past Mid-Cap Recommendation Performance

In volume 33, issue No 23 dated Oct 15-28, 2018, we had recommended four mid-cap stocks under our cover story titled “Mid-Cap stocks to cheer your portfolio” We had recommended Bhansali Engineering, Hindustan Oil Exploration Company, Parag Milk and Repco Home Finance. We have booked profit in two of the four recommendations, out of which Hindustan Oil Corporation has delivered an exceptional performance, gaining 17 per cent within a month. We recommended our investor-readers to book profit in Repco Home Finance in a period of approximately 3 months from the recommended date. Bhansali Engineering Polymers and Parag Milk are still open from our side as they have not performed up to our expectations and have negatively impacted our mid-cap portfolio.

Hitesh Jain
Senior Analyst – Institutional Equities, Yes Securities.

"We believe the market is in a consolidation phase since 2018. It has been so since early 2018 and the consolidation should last for the remainder of the year 2019 and some part of 2020. Paradoxically though, we expect the Nifty to inch upwards in 2019 on the strength of only a handful of blue-chip counters. The broader market will continue to remain lacklustre, while there is scope for more pain in mid-cap/small-cap stocks. The market support may likely come from rate cuts by RBI, enhancement in system liquidity and credit, government reforms and even the US Fed cutting interest rates. A thin stock participation will mean that an already heavy market keeps getting heavier. We also envisage a massive correction somewhere down the road, may be at the end of 2019 or early 2020. This should mark the end of this consolidation period. However, our recommendations on an average reflect an annualised return of 32 per cent."

Ajit Mishra
VP – Research, Religare Broking

What is your outlook on midcap stocks at this point in time?

Mid-cap stocks (Midcap index) have fallen around 23% since a year and are down ~13% in the last quarter. This is largely attributed to factors such as gloomy demand scenario, poor earnings and corporate governance issues in some of the mid-cap stocks. However, recent measures taken by the government such as the rollback of FPI surcharge, stimulus packages, RBI's transfer of reserves of Rs 1.76 trillion and mega amalgamation of PSU banks are definitely positives for the overall economy, but it would take some time to show the desired results. This will benefit the overall markets, including the mid-cap stocks, which are currently trading at attractive valuations. However, investors should stick to stock-specific approach and buy only those stocks which have a good promoter track record, low leverage as well as healthy growth prospects. Investors should strictly avoid stocks which have run into trouble owing to mounting debt, promoters' pledge or several other company-specific issues.

How is investors' sentiment towards mid-cap stocks?

Investor sentiments seem to be improving for the mid-cap stocks as Midcap index's underperformance with benchmark indices have narrowed down in the last 3-4 months. This is largely due to valuation correction in mid-caps, which has made them attractive to investors. However, the sentiment has still not turned entirely positive owing to subdued Q1FY20 earnings, poor visibility of earnings going forward (particularly Q2FY20) due to economic slowdown. Hence, barring few stocks, many mid-cap stocks are hovering at their 52-week lows and could offer good risk-to-reward ratio, provided the situation improves in the coming quarters. 

Pradeep Kumar Kesavan
Senior Vice-President
Institutional Equity Research, Elara Capital.

Are mid-caps looking attractive right now?

Mid-caps today are trading at ~25% discount to large-caps and are looking attractive from a valuation standpoint. If we look at the Nifty Midcap 100 universe, more than 25% of the index constituents are trading at “deep value” of the “value” buckets, where the market is strongly discounting these companies’ future growth prospects. This, coupled with robust earnings growth expectations over the next couple of years, makes us believe that mid-caps are pretty attractively poised at this stage.

What are you advising your clients on mid-caps stocks? 

Our advice is to prefer good quality mid-cap stocks with strong earnings visibility. We prefer companies that have (i) consistent history of generating superior returns, in excess of cost of capital, (II) a stable or improving operating margin profile (III) moderate to low levels of leverage and (IV) ability to generate free cash flows consistently.

Umesh Mehta
Head of Research, Samco Securities.

"Nifty Midcap 100 has fallen over 27% since highs of January 2018 and in the same period Nifty 50 has remained almost flat with an increase of a mere 2.6%. Hence, mid-cap stocks are available at cheaper valuations. However, the valuations are not the only thing investors should look at while getting into stocks and in order to get the alpha in high beta stocks such as mid-caps, it is essential for investors to time the markets correctly and pick mid-caps at bottoms, but currently due to the liquidity squeeze and slowdown in the economy, it is not the right time to pick mid-caps."

Conclusion:- 

BSE Midcap index made an all-time high on January 18 and since then the mid-cap stocks have been on a downward spiral. Investors are stuck with underperforming mid-caps even as fresh money is hesitant to come into mid-cap stocks as the preference for smart money is still the large-caps. While we believe that the mid-cap stocks are not totally out of the woods yet, the number of investing opportunities is increasing as the valuation gets attractive. The prospects of higher growth in earnings in mid-caps cannot be ignored as and when the economy recovers. 
 
Investors need to take a real long-term view (five years) while choosing the mid-cap stocks and invest in a staggered manner, apart from following the basic portfolio hygiene. There is no reason to give up on mid-caps, nor is there any scintillating investing opportunity in the space. Investors can afford to be cautiously optimistic in mid-cap stocks at this point of time and be selective while picking stocks that reflect strong fundamentals.

Methodology

To come up with a ranked list of mid-cap stocks, we took into consideration four crucial parameters. The first includes market capitalisation. The second and third parameters obtained from the Profit & Loss Account including Sales and Net Profit. Lastly, we factored in the returns earned by investors by means of dividends. This is because we want investor-friendly companies to be featured in our list. Since the face value of the shares is different for each company, we made sure to rebase the dividends by calculating them as a percentage of the face value. This rebased dividend then became comparable for the purpose of ranking. 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 FY18 into profits in FY19. Improving

Financials : Although these companies still reported losses in FY19 as they did in FY18, 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 FY19. 

A consolidated ranking was done in each category to arrive at the list. 

All the raw financial data is sourced from Ace Equity.

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