High valuations of mid-cap stocks a concern: CLSA

Foreign brokerage CLSA has raised concerns over the high valuations of midcap stocks

Foreign brokerage CLSA has raised concern over the high valuations of mid-cap stocks.

The one-year forward valuation premium of the Nifty Midcap 100 index (NSE Mcap) was near an all-time high, it said. This is quoting at a 12.6 per cent premium to Nifty valuations, significantly above its 10-year average discount of 9.8 per cent. The top 10 stocks combined occupy 28 per cent of the index weight and all trade significantly above their 10-year median valuations, the brokerage added.

Shares of mid-cap and small-cap companies have surged to record highs, driven by global liquidity and expectations that the worst might be over for India Inc on earnings. Expectations of a good monsoon and policy rate cuts have also driven up valuations. As on Friday, the Nifty Free Float Midcap 100 closed at 15,336, after a record high of 15,745 on September 8. The gauge has gained 13 per cent in the year to date, compared with gains of 10 per cent for the benchmark Nifty.

CLSA said consensus was building on a 54 per cent earnings growth expectation for the NSE Mcap but this was largely driven by the materials and energy sectors (weightage of 21 per cent) and public sector banks (three per cent). Adjusting for these sectors, the FY17 consensus growth estimate was only 12.3 per cent, it said.

The brokerage suggests a selective approach to mid-caps, with a bias towards quality and growth visibility. Its top picks in the space are Arvind, Crompton Consumer, Dr Lal PathLabs, IDFC Bank, IndiGo and Sobha Developers.

An earlier report by Bank of America Merrill Lynch had noted the premium at which mid-cap stocks were trading over their frontline peers had surpassed the earlier peak premium of 2008.

Kotak Institutional Equities, in an August 30 research note, said it was dropping its mid-cap portfolio entirely, as most of the stocks in its coverage universe were trading at very rich or fair valuations. Kotak tracks 100 stocks with a market capitalisation below $3 billion.