Tread with caution: Anoop Bhaskar

Economic revival over the next few years, boosted by benign interest rates should aid earnings. However, valuations, especially in the small cap side may have overshot for the near term

Investors who had spotted (and invested) in either a Greencrest Financial or Ybrant Digital should be laughing all the way to the bank. With trailing 12 month returns of 3,074% and 1,976%, respectively, these two "relatively" unknown companies are the best performing stocks of the BSE Small Cap Index. The index has been no spring chicken itself delivering a whopping 73% return.

Small- and mid-cap stocks are traditionally expected to outperform at the turning points of the economy. The same is true on both sides of the move! In 2011 and 2012, as the economic growth fell, these segments nosedived. Since Sept 2013, there has been an increasing belief that the economic cycle has bottomed and growth should revive, so have the small- and mid-cap indices. Buoyed by the strong election mandate, this belief has got even more reinforced. As a result, the performance of the small and mid caps segments has been spectacular, easily overshadowing the Nifty or the Sensex.

As is shown in the table, roughly 45% of the stocks (by number) in the BSE Small Cap Index, 32% of the BSE Mid cap Index and only 4% of Nifty stocks had doubled during the last 12-month period. Roughly 23% of BSE Small Cap Index stocks, 10% of Mid Cap stocks, none from the Nifty had registered a return of 200%+. So spectacular, has been the performance of these two segments over the last 12 months, it has helped cover two years of underperformance. Not surprisingly, investors, too, seem to have rekindled their affinity to these segments.

With earnings growth growing at a sedate pace, re-rating has been the primary driver of the market in general and for the small- and mid-cap segments in particular. These segments, which were trading at a discount to the Nifty, now trade at a premium.

No doubt, an economic revival over the next few years, boosted by the benign interest rate environment should boost earnings, valuations, especially in the small cap side may have overshot for the near term. For investors, the sharp momentum in small-and mid-cap segments should act as a cautionary sign. While the prospects for the future look appealing and tailormade for a sustained rally in these segments, caution may be the best part of valour for investors at current level.

The author is Head-Equity, UTI AMC (Views expressed in the article are of the author and not the organisation he belongs to)