Analysts cautious as mid, small-caps climb wall of worry

Though analysts remain optimistic on the road ahead for the markets, they don't find the risk-reward favourable in these two market segments

Buoyed by liquidity and a healthy financial performance in the June 2016 quarter, shares of mid-and small-cap companies are on a roll with S&P Midcap index and the Nifty Mid100 indices hitting their respective record high levels on Friday.

In the past one-month, the S&P BSE Midcap index has surged 8%, while the small-cap index has rallied 4.6% in comparison to 1% gain in the S&P BSE Sensex.

Among individual stocks, YES Bank, Tata Chemicals, Piramal Enterprises, Kansai Nerolac, Divis Laboratories, Shriram City Union Finance, Delta Corp and Shalimar Paints are trading at their respective lifetime high.

Adhunik Industries, Indian Hume Pipe, Sudarshan Chemicals, Jubilant Life Sciences, RPG Life Sciences, Aptech, GOCL Corporation and Rico Auto Industries from the small-cap index have rallied an over 50% each during the past one month.

“The mid-and small-caps have climbed a wall of worry and has been largely by liquidity. We have been cautioning against the valuations of some of the stocks in these segments. The money has been chasing broader markets instead of the large-caps. In this backdrop, any negative news will impact the mid-and small-cap stocks in a significant way,” warns Prakash Diwan, director, Altamount Capital Management.

Besides liquidity and a pick-up in financial performance, hope of a cut in interest rate, market rally, especially in the mid-caps, has also been driven by a pick-up in monsoon and the government’s resolve to get the GST (goods and services tax) Bill cleared in the monsoon session of Parliament. That apart, analysts are hopeful that the worst may be getting over for India Inc as regards earnings.

Kalyani Steels, in fact, became multi-bagger, appreciating over 100% from Rs 184 to Rs 376 in past one-month. The company had reported a strong 62% year-on-year (y-o-y) jump in net profit at Rs 46.80 crore for the quarter ended June 30, 2016 (Q1FY17), against profit of Rs 28.89 crore in the year ago quarter.

Though analysts remain optimistic on the road ahead for the markets in the days ahead, don’t find the risk-reward favourable in these two market segments that have outperformed the benchmark indices. One needs to be stock-specific and invest only where there is earnings growth visibility for the next few years, they say.

 

“I don’t think the risk-reward is favourable in these two segments and are in an over-bought territory. Even-based risks include a delay in goods and services (GST) tax bill beyond the winter session of Parliament or a correction in the S&P 500 index in the US. I suggest investors use an upside to book profit. Having said that, I still find some value in auto ancillaries, packaging, metals and agri-based industries,” Diwan adds.

Since the presentation of the Budget in February when the sentiment turned positive for the overall market, the S&P BSE Mid-cap index has outperformed the markets by rallying around 36%, while the S&P BSE Small-cap index has gained around 30%. By comparison, the S&P BSE Sensex and the Nifty 50 indices have gained around 21%.

“We feel this is the final leg of the rally and investors need to be extremely cautious now. Event-wise, we are nearing the US election and the news-flow from Europe is also not too encouraging. Given this, investors should buy only quality stocks where the growth is visible,” cautions A K Prabhakar, head of research at IDBI Capital.

Among the lot, he still likes Power Grid, NBCC, LIC Housing Finance, Mahindra Holidays, City Union Bank, Sundaram Fasteners, Arvind, Astral Poly, Century Ply, Welspun India, Jagran Prakashan, PI Industries, Gujarat State Fertilizer & Chemicals (GSFC) and Motilal Oswal OFS.