Mid-cap rally likely to continue

Many are still trading 40-50% below their peaks, indicating the extent of opportunity left for investors

In the past month, mid-and small-caps have outperformed large-caps by wide margins but there is still juice left for investors, given the valuation gap, say analysts.

During the period, the BSE mid-cap and small-cap indices are up five per cent each, against a sideways movement in the benchmark Sensex. Analysts say it will take a much bigger rally for the valuation gap between large- and mid-cap to close.

“In the current rally, many large-cap stocks such as TCS, Sun Pharma, Tata Motors, Lupin, ITC, Hindustan Unilever, HDFC and HDFC Bank, among others, made new all-time highs earlier this year. In comparison, most mid-caps are still trading at 40-50 per cent below their peak despite the recent rally, indicating the extent of opportunity left on the table for investors,” says Nitin Jain, head of capital markets (individual clients group) at Edelweiss Capital. Many stocks have a lot of ground to cover, given the potential earning upside that they could provide in next three to five years, he adds.

According to analysts, the mid-cap rally is here to stay, given the huge valuation gap and recent improvement in the economy’s growth fundamentals. “A value investor is spoilt for choice right now given that many mid-caps trading in low single-digits in terms of price to earnings multiples, despite the recent rally,” says a senior analyst at a leading Mumbai-based brokerage house.

In comparison, the Sensex has traded at 18 times its net profits in the past 12 months. Despite the current rally, 70 per cent of BSE-500 companies are still trading below their closing price on the last day of trading in 2012.

To others, this signals an increase in market breadth and the first sign of a return of domestic investors. “Mid-caps and small caps stocks are mostly owned by individuals and domestic mutual funds. A rally in these counters suggests that domestic investors, specially high net worth individuals and mutual funds, have turned buyers,” says Alex Mathews, head of research at Geojit BNP Paribas Financial Services.

Wealth managers confirm this. “Earlier, individuals were in a wait-and-watch mode, awaiting the outcome of the 2014 Lok Sabha polls. Now many of them have begun to invest around 30 per cent of their total equity allocation, saving the rest for the post-election purchases,” says Rajesh Saluja, chief executive and managing partner at ASK Wealth Advisors.