Low free float behind rally in most mid-cap, small-cap stocks: Kotak study

Stocks in the top and bottom performance quartiles had different free floats. Delivery value, relative to free float, was much higher for the top performers

The recent rally in mid-caps and small-caps is led by top-performing stocks with lower free float than underperforming ones, according to a study by Kotak Institutional Equities.

Better fundamentals of a few, a strong narrative expecting high potential return, among other factors are likely drivers behind the exceptional performance of the mid- and small-cap stocks, said the study.

Nifty SmallCap 100 and Midcap 100 have surged 30% and 23% year to date, respectively, compared with a 5% rise in benchmark Nifty 50. Ongoing volatility has stalled the rally for now.

Low Free Float 

Stocks in the top and bottom performance quartiles had different free floats.

The top quartile of outperforming companies have lower free floats--the proportion available for trading--than their underperforming counterparts, suggesting that free float may have created a sense of scarcity, driving up demand for these stocks.

Free-float market cap is inversely proportional to the volatility in the market. Higher free-float indicates that investors are rapidly selling and purchasing shares. Similarly, if free-float is low, it indicates higher volatility.

According to Kotak, many low free float stocks have seen a sharp surge in delivery volumes, which may reflect the market’s heightened expectations.

Free float of top performing mid-cap. stocks, October 2023 

State-run Mazagon Dock Shipbuilders and Indian Railway Finance Corporation (IRFC) occupy top slots in the list of 20 best-performing midcap stocks. Fertilizers and Chemicals Travancore (FACT), Macrotech Developers, Vodafone Idea, Sun TV Network and Adani Power also feature on this list.

Free float of bottom 20 mid-cap stocks 

Kotak  also lists the bottom 20 stocks in terms of returns over the six month period. Federal Bank with 100% free float finds itself in this list along with Navin Fluorine (70%), Voltas (69%), Yes Bank (61%) and Tata Chemicals (61%). The average free float of the 20 stocks stands at 48%.

Top performers have seen a sharper increase in delivery volumes compared with worst performers over March-September 2023

Change in monthly delivery value for best and worst performing mid-cap. stocks (%)

Meanwhile, delivery value, as a proportion of free float was significantly higher in the top quartile of performers versus those in the bottom, noted the study. This too has led to increasing expectations of strong returns from the small- and mid-cap space, as reflected in increased inflows in small- and mid-cap mutual funds. At least 40 per cent of all equity inflows this year have been in the mid- and small space.

"Interestingly, delivery value has seen a sharp decline in October 2023 versus September 2023 and large cap. stocks have not shown any meaningful deviations in their delivery volumes." said the study.

The brokerage had observed a similar phenomenon in the mid-cap rally of 2017 when several mid-cap stocks delivered phenomenal returns. Stocks with lower free float outperformed their peers. However, the Nifty Midcap-100 Index

declined 15% in 2018 and most companies in the top quartile of performance saw significant value erosion. 

"We are only highlighting the similarity in terms of performance and float and not drawing any conclusions from 2017 about the fate of the current rally in mid- and small-cap. stocks," it added.

Kotak believes that the market's high expectations for midcap and smallcap stocks may be overly optimistic. Stock returns have outpaced fundamental improvements. The recent price correction in some of these stocks reflects market nervousness about holding them after such significant gains. To maintain their strong stock performance, the top-performing companies might need to demonstrate more significant improvements in their financial and operational performance, the report said.

Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd