The long and short of the mid-cap rally

Mid-cap and small-cap stocks have rallied significantly in the past three years, even outperforming the benchmark Sensex. The Nifty Midcap 100 and Smallcap 100 have outperformed the Nifty 50 by 15 per cent and 16 per cent since August 2013.

The rally in some cases has been backed by improvement in business fundamentals. But, in most other cases, it has been due to re-rating (a term used for assigning a higher price to earnings multiple for a stock or index). A report by Ambit Capital says stocks in the BSE 500 index have seen the sharpest re-rating in the past few years even though their financial metrics have worsened. 

“Such a phenomenon can be explained by the hope of earnings reversal that drives the sharp price multiple re-rating for small-midcap even for the stocks that do not deserve such a re-rating. However, the risk is when the earnings revival does not pan out eventually due to underlying business weakness for such stocks; they will be susceptible to a sharp de-rating,” said Saurabh Mukherjea, chief executive officer, Ambit Capital.

Mukherjea says strong domestic inflows have lifted most boats. Between June 2015 and December 2016, the domestic institutions have net bought equities worth Rs 1.16 lakh crore driving up the share prices in some cases.