Sharp earnings downgrade, uncertain outlook impede small-cap recovery

Small-cap index still down 17% YTD, even as Nifty50, mid-cap indices back in green.

The Nifty Smallcap 100 Index is down 17 per cent year-to-date, even as the benchmark Nifty50 and the Nifty Midcap 100 are back in the green. Sharp earnings downgrade and an uncertain outlook have impeded recovery in shares of smaller companies from this year’s lows, say analysts.

According to a recent report by BofA Securities, the earnings estimate for the Nifty Smallcap Index has been cut 7 per cent and 1 per cent for 2022-23 (FY23) and 2023-24 (FY24), respectively, this year.

By comparison, the Nifty Midcap pack has seen earnings upgrade of 5 per cent and 8.7 per cent for FY23 and FY24.

The Nifty had tumbled as much as 16.5 per cent from this year’s highs in June amid global risk-off. The fall was sharper for the mid- and small-cap universe at 21 per cent and 33 per cent, respectively.

 

A fall of more than 20 per cent from a recent high is considered to be a ‘bear market’. While the Nifty and the Nifty Midcap indices have managed to recoup losses, those with small-cap exposure are still left licking their wounds.

“Large-cap firms have a bigger market share. The ones in mid-caps will be filled with second and third biggest players in a sector. The small-cap will comprise companies that are loss-making or do not have significant market share. We had high inflation, commodity prices rose, and raw material costs went haywire. For larger companies, it is easy to pass on higher raw material costs by making small hikes to their prices since they have economies of scale. Moreover, small-caps are fancied by retail investors who are not aggressive at the moment. Foreign funds that mostly invest in large-caps and select mid-caps are buyers right now,” says A K Prabhakar, head of research, IDBI Capital.

Earnings downgrade notwithstanding, the Street is still pencilling in lofty earnings growth from small-caps. The consensus growth earnings per share estimate for the small-cap pack is 36 per cent and 24 per cent for FY23 and FY24, respectively. By comparison, it is 15 per cent/16 per cent and 19 per cent/27 per cent in FY23/FY24 for the Nifty and the Nifty Midcap, respectively.

Due to the Nifty’s sharp outperformance of the Nifty Smallcap Index, the latter is now commanding a valuation premium. However, experts say larger companies can withstand global risks better.

“Large-caps have recovered fully; the valuation comfort is not there in many sectors in the large-cap space. It is better to stick to large- and mid-caps. One can allocate between 10 per cent and 20 per cent to small-caps, 30 per cent and 40 per cent to mid-caps, and the rest to Nifty stocks until clarity emerges on some of the global headwinds. If one has huge exposure to small-caps and things go south, it is difficult to exit small-caps overnight," says Chokkalingam G, founder, Equinomics Research & Advisory.

Typically, investments in small-caps are considered to be high-beta. In simple words, they tend to fall and gain more than large-caps during a market upturn/downturn. If the latest rebound extends, small-caps could perform better, observe experts.

“This sharp rally was initially assumed to be a bear-market bounce. It’s natural for investors to look for pockets where valuation looks reasonable. Therefore, the hunt for mid-caps. It is natural during strong rallies that mid-caps follow large-caps. Then the rally percolates down to small-caps and penny stocks,” says Ambareesh Baliga, an independent analyst.

Autos, metals and banks lift indices on volatile day

Benchmark BSE Sensex and Nifty50 snapped their two-day losing streak to close nearly half a per cent higher in a volatile session on Tuesday following gains in banking, metal and auto stocks. The 30-share BSE Sensex rebounded more than 1,000 points, showing net gains of 257.43 points while the broader NSE Nifty rose by 86.80 points. (PTI)