Mid-, small-cap stocks on a roll but experts see bubble ahead

S&P Midcap index and the Nifty Mid100 reached their respective record highs in intra-day deals on Monday

Buoyed by global liquidity and healthy financial performance in the June quarter, shares of mid-cap and small-cap companies are on a roll, with the S&P Midcap index and the Nifty Mid100 reaching their respective record highs in intra-day deals on Monday.

In the past month, the S&P BSE Midcap index has risen by six per cent and the small-cap index has rallied three per cent, in comparison to a 0.7 per cent rise in the benchmark S&P BSE Sensex till Monday.

YES Bank, Tata Chemicals, Piramal Enterprises, Kansai Nerolac, Divis Laboratories, Shriram City Union Finance, Delta Corp and Shalimar Paints are some stocks from these two segments that are trading at a lifetime high.

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

Beside liquidity and a pick-up in financial performance, beside hope of a cut in interest rates, the market rally, especially in mid-caps, has also been driven by a pick-up in the monsoon and the government’s resolve to get the goods and services tax (GST) Bill cleared in the recent session of Parliament. Also, analysts are hopeful that the worst might be getting over for India Inc on earnings.

Kalyani Steels rose a little over 100 per cent in the past month, from Rs 184 to Rs 376. The company had reported a 62 per cent year-on-year (y-o-y) jump in net profit at Rs 46.8 crore for the quarter ended June, against one of Rs 28.9 crore in the year-ago quarter.

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

“These segments are in over-bought territory. Event-based risks include a delay in GST legislation 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 automobile ancillaries, packaging, metals and agri-based industries,” Diwan adds.

Since the Union 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 per cent, while the S&P BSE Small-cap index has gained 30 per cent. By comparison, the benchmark S&P BSE Sensex and the Nifty50 have gained around 21 per cent.

“We feel this is the final leg of the rally and investors need to now be extremely cautious. 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, Jagran Prakashan, PI Industries, Gujarat State Fertilizer & Chemicals and Motilal Oswal Financial Services.