Mid, small caps offer opportunities, but hold stocks for at least a year

As market pundits had predicted, the stock market rally has become broader after the Lok Sabha elections ushered in a stable government. And the positive sentiment seems to have rubbed off on retail investors as well. The renewed interest in the mid- and small-cap space clearly indicates that retail investors’ risk-taking ability is on the rise.

And it’s not just stocks, investors are putting in money in mutual funds as well. In May, net inflows into equity schemes rose 17 per cent to Rs 5,407 crore, and more than 50 per cent of this money — Rs 2,687 crore — went into mid- and small-cap schemes. This was more than double that in April. 

Says Mahesh Patil, co-chief investment officer, Aditya Birla Sun Life AMC: “There aren’t immediate triggers for any mid- and small-cap stock rally over the next two-three months. But due to the correction over the last year, valuations have turned attractive. Many investors had stopped allocation to mid- and small-caps since last year as they continued to slide. We feel that valuations have turned attractive for an investor to start allocating to mid- and small-cap stocks.”

Adds Arun Kejriwal, investment expert: “There are mainly three reasons why investors are looking at these stocks and funds. Most investment experts are advising them; the prices of many stocks have fallen by 50-60 per cent, and large caps are quite pricey now due to an excessive focus on the headline index — the Sensex or Nifty. The strategy, per se, isn’t bad because there is a good likelihood that many good bets will pay rich dividends.”

Patil is looking at themes like consumption (consumer and consumer discretionary), financials (private and corporate banks, and select non-banking financial companies), and industrials (capital goods, cement and select infrastructure companies).

According to G Chokkalingam, founder, Equinomics Research and Advisory, if you are a direct stock picker, small- and mid-cap space is the best right now as they have been beaten down badly. “If we exclude the 15 index stocks that have performed well, over 90 per cent of the stocks with a market cap of Rs 1,000 crore are down year-on-year. Also, in the small and mid-cap space, there are a lot of unique ideas that investors cannot find in the broader index. There are companies in the space that have been showing consistent revenue and profit growth year on year.”  

Chokkalingam gives the example of caustic soda companies or some mid-sized information technology companies. This is the only space where a stock picker can find pockets of opportunity. 

However, most experts believe that investors would do well to stay cautious. While there are the winds of change, there are both domestic and external threats as well. The economy is slowing, and the risks emanating from the US-China trade war could stifle the market rally, and there could be a correction as well. And when the markets tumble, it is the mid- and small-caps that take bigger knocks than well-established stocks. Kejriwal believes that investors buying any stock in these segments should hold on for at least a year, whereas Patil recommends a two- to three-year horizon. Invest in a staggered manner, or if you lack confidence in your stock-picking skills, pick a mutual fund.