Don't dump mid-cap stocks

Experts say one should not broad-brush and exit from this segment at the moment

2016 hasn’t started off on the best note for Indian equities, with the CNX Nifty losing nearly 500 points (nearly six per cent) so far this year. More worrisome is mid-cap stocks faltering at a steeper pace. The CNX Mid-Cap index is down a little over 10 per cent, a fall of around 300 basis points more than the CNX Nifty since the start of 2016.

With only a handful of mid-cap stocks such as Torrent Power, Rajesh Exports, Indraprastha Gas, Emami and Mindtree (of 100 constituting the CNX Mid-Cap index) still in the green, questions surface on what investors should do with these shares.

The worries might compound if one notes only 20 mid-cap stocks have survived the stock market carnage since that index touched its peak in August last year. Stocks from the banking space such as DCB Bank, Bank of India, Union Bank of India and Canara Bank have plunged by 43-50 per cent. Others such as Power Finance Corporation, Jubilant FoodWork, Sintex Industries, Apollo Types and Gujarat Pipavav Port have declined 35-38 per cent since August 2015.

Dipen Shah of Kotak Securities explains that as several mid-cap stocks had run up much ahead of large-caps last year, it is but obvious that mid-caps have ceded more. Ajay Bodke of Prabhudas Lilladher feels at this juncture, large-cap stocks make for a better buy in terms of valuation as compared to mid-caps given the recent correction. “As sanity returns in the market, large-cap stocks will be the first preference for institutional investors,” he explains.

That said, both experts feel one should not broad-brush and exit from mid-cap stocks at the moment. Deven Choksey of KR Choksey Investment Managers also believes that an investor cannot make money (higher returns) in a market such as this if one does not invest in mid-caps. Take the period from January 2015, with 41 out of 100 mid-cap stocks still in the green despite a tepid equities market. Much as in the case of large-cap stocks, the mid-cap space also seems to have a positive bias towards defensives, such as Natco Pharma, Ashok Leyland, Britannia Industries and Marico. These gained between 40 per cent and 60 per cent since January 2015.

Rajesh Exports, up 377 per cent since then, is an outlier in the pack of outperformers. Surprise entrants in the list are stocks from the non-banking financial sector, such as Bajaj Finance and Bajaj Finserv with returns of 61 per cent and 44 per cent, respectively.

Interestingly, with crude oil prices constantly making fresh lows and the outlook for gas availability improving, stocks in the oil and gas segment such as Hindustan Petroleum, Indian Oil, Gujarat State Petronet and Indraprastha Gas continue to hold up their gains (up 20-45 per cent since January ’15).

Even on a longer time horizon, while the Nifty returned 19 per cent since January 2011, the mid-cap index grew by 36 per cent during this period. Stocks such as Vakrangee, Bajaj Finance, Amara Raja Batteries and Page Industries have outperformed the mid-cap index with gains of 700 to over 900 per cent during this period. That of Ajanta Pharma has risen from Rs 29 in January 2011 to now trade at Rs 1,158. Only 34 of 100 stocks would have been wealth destroyers in this period, indicating that a screening process is the key to benefit from mid-cap stocks.

Choksey advises that investors need to pick debt-free companies which reinvest their surplus cash into the business, while being hedged against foreign exchange fluctuation. Bodke feels mid-caps such as Suzlon, Cummins India, Bharat Forge and Shriram Transport will make a remarkable comeback when the market recovers. Companies with strong businesses, a focus on domestic markets and where regulatory interference is minimal could be considered among mid-caps.
CONSIDER WHILE PICKING MID-CAPS

• Opt for companies with a strong business model, with reasonable amount of entry barrier/advantage and a large potential market that will allow it to grow for many years
   
• Companies with record of good corporate governance should get preference
   
• Consider companies with debt-free or less leveraged balance sheet or one with free cash reserves, which will help lower risk
   
• Look for companies which reinvest surplus funds into the business and/or earn a reasonable return on equity of over 15 per cent a year in existing business
   
• Check how the company hedges against forex fluctuation