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Analysts remain bullish on mid, small-caps despite stellar show

Topics mid cap stocks | Markets | Jefferies

The current up move, according to analysts at Edelweiss Securities, closely resembles the rally post one global financial crisis (GFC) in 2008-09
Despite the sharp outperformance on a year-to-date (YTD) basis, analysts still believe small-and midcaps (SMIDs) have more steam left. Though there can be an intermittent correction, stock selection will be key, they say.

The optimism stems from the better-than-expected rebound in economic activity after a stringent lockdown for a few months in 2020 coupled with efficacy of the COVID vaccine.

On Friday, the S&P BSE Small-cap index hit a new high of 21,411, up 1 per cent on the BSE in intra-day trade as power, textiles, jewellery, industrial machinery, chemicals and packaging stocks surged. The index surpassed its previous high of 21,389 hit on March 3, 2021.

The current up move, according to analysts at Edelweiss Securities, closely resembles the rally post one global financial crisis (GFC) in 2008-09, not just in quantum and speed, but also the way small-and mid-cap (SMID) indices have outperformed large-cap peers.

“During November 2008-December 2009, Nifty / Midcap 100 / Small-cap100 had rallied 90 per cent /125 per cent / 132 per cent; this time, these indices have rallied 100 per cent / 114 per cent / 140 per cent. For SMID indices, during both periods, valuations have doubled,” wrote Aditya Narain, head (research) for institutional equities at Edelweiss Securities in a recent report co-authored with Alok P. Deshpande and Sameer Chuglani.

Another key factor that has aided the sharp rally, especially in the mid-cap segment is the ample liquidity with global central banks remaining in an ‘accommodative’ mode. That apart, retail investors have latched on to this market segment over the past one year in a bid to make a quick buck, analysts say. With the economy opening up, companies, too, are back in business and the demand for products is steady. All this augurs well for companies, especially in the mid-and small-cap segment.

Historically, a phase of disruption has been followed by outperformance in Midcap and Small-cap indices (2009, 2016 and 2017). The trend has continued with both the indices outperforming Nifty 50 in CY20 and YTD CY21, data show.

The recent rally in some of the individual stocks has been sharper. On YTD basis, Adani Enterprises, IDFC First Bank, Adani Transmission, Cummins India and BHEL have gained 52 per cent to 88 per cent, ACE Equity data show.

Valuation concerns
That said, analysts do caution against the valuation at which these indexes and some of the stocks are trading at. Besides, rising commodity prices, inflation and bond yields remain one of the key risks for the markets.

The Nifty Midcap Index has sharply rebounded by over 70 per cent since June 2020 and now trading at 24x forward price-to-earnings (PE), which analysts at Jefferies say is 29 per cent / 53 per cent premium to its 5-year / 10-year historical average Also, the current PE is converging to pre-Covid peak PE multiple of 26x.

“We recommend a bottom-up stock picking approach in SMID. Earnings growth in our SMID universe could be aided by cyclical recovery in property, electrodes, autos, select industrials and healthcare stocks. Average return on equity (RoE) is likely to expand by 520 basis points (bps) to 19.2 per cent by FY23 (14 per cent in FY21), with better profitability. Key growth catalysts could be government initiatives, housing revival, market share gains, indigenisation, new product launches and balance-sheet strength,” says Sonali Salgaonkar, an analyst tracking the SMID segment at Jefferies.

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