Will the small and mid-cap rally sustain?

The valuation gap between large and small-caps is high and is likely to narrow in the coming months

While the large-cap indices have been near their all-time highs and catching all the attention, there’s another segment that is rising faster and is showing a huge buying interest. In the past month, BSE’s Small- and Mid-cap indices have outperformed the larger BSE Sensex as many investors look for value in a segment that was beaten down for the whole of last year. Small- and Mid-cap indices increased 4.5 and 4.2% as the Sensex gained 2.2% this past month.

It’s a story that is being quietly played out as the valuation gap of large-cap stocks has been steadily rising. Valuation of the BSE’s Mid-Cap index has slipped this passed year and is down from 22 times earnings to around 7 times currently.

Market watchers say that at these lower levels many of these stocks make compelling valuations, and the buying is not just restricted to a few segments like IT or pharma companies. Says G Chokalingam, managing director, MD and CIO, Centrum Wealth: “If you look at the large-caps, the gains are happening only in a few segments. In mid-caps, there are gains in a lot of different segments that have been beaten down and seeing value buying.”

It’s also the space that is most likely to see some buying interest by retail investors as they begin to gain more confidence in the market. Chokalingam also says that retail investors are likely making a toe-hold entry into this segment in the small and mid-cap space.

There’s also a growing segment that is echoing that the small- and mid-cap rise will sustain in this market. Says Rajen Shah, CIO, Angel Broking: “Small and mid-cap space has bottomed out, and this I believe, presents a buying opportunity. Since January 2008, mid- and small-cap indices are down 48 and 63%. If one buys around the bottom, one can make fabulous returns.”

Experts say that investors will have to narrow down to specific quality stocks where there’s a revival due to the fall in the rupee and where there’s a reasonable amount of cash flow. Says Chokalingam: “Investors always have to choose carefully in this space and give these investments enough time for the fundamentals to play out.”