Return of the big boys: Why large-cap stocks might be the best bet for 2018

Investors aligning their investments to indices would be better placed betting on large-caps in 2018, it would seem.

After four years of underperformance, the blue chip-focused Sensex and Nifty are expected to fare better than the small-cap and mid-cap indices, going by forecasts of brokerages. According to Bloomberg consensus data, analysts are predicting an average eight per cent upside to Sensex companies, compared to three to four per cent expected on the BSE mid-cap and small-cap indices.

Analysts say the valuations of broader markets look stretched and revival in the earnings of smaller companies might lag larger peers. Experts say earnings visibility is better for blue-chip stocks and given the rich valuations, good quality stocks could be better bets. 

The one-year forward price to earnings (PE) multiple of the BSE mid-cap index is currently 30; the BSE small-cap index is commanding a multiple of more than 50. This is way higher than the long-term averages. On the other hand, the Sensex is trading at a one-year forward PE of 19 times, two notches above its long-term average.

The market already seems to be witnessing early signs of outperformance by large-cap stocks in 2018 so far. The Sensex has rallied a little more than three per cent; the BSE mid-and small-cap indices have gone up only 0.6 per cent and 2.1 per cent, respectively. 

“If you are an investor today, the tilt today should very clearly be towards large-caps. Mid-caps have consistently outperformed for the past few years. Even in a sector like IT, we have seen mid-caps outperforming. Lately, large-caps have begun to play catch-up. A lot of innovation is coming through mid-caps but large-caps are doing a better job at executing it. They have the depth, maturity and resource to execute new ideas. A classic example for this is the financial technology sector,” said Dipen Sheth, head of institutional research, HDFC Securities.

Earnings estimates are currently in favour of blue-chips. The earnings per share (EPS) of Sensex firms has got revised upward by 17.5 per cent in the past month, due to optimism over recovery in earnings. On the other hand, the estimates have remained more or less the same when it comes to the broader indices.

“The premium of mid-caps over large-caps has widened further and is 70 per cent, the highest since 2008. Given the high earnings growth expectation built into stock prices, there is a risk of earnings disappointment,” said Elara Securities in a note to investors.

However, analysts say there are still bright spots among the mid-cap and small-cap segments, which could provide good investing opportunities. Sectors such as automobiles, cement and IT still have stocks in the mid-cap segment which could provide solid returns. 

“There are still some good investment opportunities in the smaller stocks, the companies with good earnings visibility and strong business models. However, spotting such stocks could be tricky, as valuations look expensive. Investors should focus on fundamentals, rather than on mere share performance,” said Prakarsh Gagdani, chief executive officer, 5paisa.com.