Can midcap, smallcap stocks continue to outperform largecap shares?

Domestic equity markets have delivered positive return to investors, but broader markets have outperformed the largecap peers with a big margin. Analysts, tracking the stocks, believe that outperformance of second rung counters, midcap and smallcap stocks, is likely to continue, despite the valuations have suggested a word of caution. To put things in perspective, the BSE midcap index has rallied more than 37 per cent in the last six months, while the index has gained 27 per cent in the year 2023. In the last one year, it has gained about 32 per cent, while its return in the last five years stood at 120 per cent for the investors. Similarly, the BSE smallcap index has soared 43 per cent in the six months period, while its rally stood at 30 per cent in the year 2023 so far. It has gained more than 35 per cent in the last one year, while its return in the last five years came in at a healthy 160 per cent for the investors. On comparison, the BSE Sensex gained about 15 per cent in the last six months, 8 per cent in the year 2023, 16 per cent in the last one year, while 80 per cent in the last five years. BSE largecap index has gained 16 per cent in the last six months, only six per cent in 2023, 12 per cent in one year and 76 per cent in the last five-year period. India continues to remain the most expensive individual country-wise market with a 12-month forward P/E valuation of 19.6 times, followed by the US with 17.8 times. However, struggling economies like Brazil, China and Russia command a forward P/E multiple less than 10 times. MSCI India premium to Asia is near 7-year mean, said a report from InCred Equities. While some of the biggest names on the street have word of caution for the second rung stocks, ASK Private Wealth see some chinks in the growing consensus of overvaluation story. "When a large part of the market is on one side, it's usually not a great side to be on. EPS multiples are not supporting the fear case," it said. According to the study by InCred, Nifty50 is commanding a one-year forward P/E of 17.5 times, while Nifty Midcap 100 index and Nifty Smallcap 100 index are commanding a one-year forward P/E of 23.4 times and 16.1 times respectively. Commenting on valuations, ASK said that there is not much difference in stretch between largecap and SMID particularly with respect to their respective historical levels. From an earnings-valuation perspective post-Covid index expansion is still lagging earnings for mid & smallcap compared to Large-caps, it said. Midcap and smallcap counters have always been more volatile than the largecap peers and valuation stretch is not very different from the largecap peers as it stays similar. The mid and smallcap counters continue to attract institutional investment over the medium-term. Stay away from the herd – no need to exit mid & smallcap portfolios. The latter seems to have better growth profiles; similar valuation stretch and somewhat behind-the-curve price-catchup to valuations as Large-caps. No compelling 'sell' case emerges, said ASK Private Wealth. Market experts see oil prices and interest rates as the key risks for the business. The US interest rate remaining higher for longer than expected may adversely impact the prospect of India in terms of flows. Several favoured larger companies are also quite richly valued, they argue. Liquidity can be the biggest risk and any reversal in the global risk environment would affect flows in equity including that coming to India. However, the timing of such events cannot be predicted, it added. "Stretched valuations could be there, as are pockets of liquidity running behind flows. Evaluate strategies with more diversified, instead of concentrated, profiles to mitigate risks." Domestic brokerage firm Religare Broking positive on sectors like IT, cement and FMCG sectors. It has picked up four midcap stocks from these sectors as it believes to have potential to perform and earn a return in the range of 16-21 per cent in the coming 9-12 months perspective. From the IT sector, Religare has short-listed Mphasis with a target price of Rs 2,960, while it has put its bet on Nuvoco Vistas Corporation with a target price of Rs 455 from the cement sector. From FMCG space, it has picked up Jyothy Labs and CCL Products India with target prices of Rs 428 and Rs 776, respectively. However, some analysts have a contrary view. They believe that bluest of blue-chips are likely to perform well considering high frequency macro indicators like credit growth, e-way bill, kharif sowing) continue to comfort economic activity ahead of forthcoming election season in five states and general election in India. However, they cite rising oil prices as a concern. The recent correction in indices, both large and mid & small cap, makes valuation attractive for large cap, while premium valuation of mid-cap index concern, said InCred Equities. "We reiterate Overweight on Nifty with target of 21,103. Easing volatility and India valuation premium to MSCI remaining near 7-year mean extended comfort," it added. Another brokerage firm, DAM Capital is positive on the stocks like KEC International Trent, Escorts Kubota, Bharat Forge, Astral, TVS Motors, IDFC First Bank, IndiaMart InterMesh, Havells India, UNO Minda and Mahindra & Mahindra Financial.