Even though broader markets have been massively outperforming benchmarks and largecaps, brokerage house Kotak Institutional Equities sees better investment opportunities and reward-risk balance in the top large-cap names than in other parts of the market.
It expects the large-cap laggards of 2022-23 to do better over the next 6-12 months while other large-cap and quality mid-cap stocks may see a period of time correction. Narrative-based mid- and small-cap stocks will eventually see large prices or lengthy periods of time correction, added the brokerage.
The Indian markets have given overall robust returns in 2023 YTD, rising almost 9 percent, however, the last 1 month was pretty volatile for the indices. Sustained foreign investor outflows, rise in crude oil prices, surge in US bond yields, concerns regarding US Fed holding rates higher for a prolonged period as well as the latest Israel-Hamas conflict in the Middle East have kept investors cautious.
Benchmark indices have shed around 1 percent in the last 1 month.
The brokerage house believes that a strange all-in-one market presents ‘rotation’ opportunities.
"The Indian market is concurrently in the bear, bull, and bubble phase. Several top large-cap stocks (and quality mid-cap. stocks) have hardly given any returns in the past 2-3 years, other large- and mid-cap stocks have delivered decent returns, while several mid- and small-cap. stocks have given fantastic returns in the past 6-9 months. The performance of sectors has also been quite different depending on the mix of large-, mid- and small-cap stocks in the sectors. The sectors with a high proportion of large-cap stocks have lagged sectors with a high proportion of mid-and small-cap stocks," it pointed out.
It also noted that five out of the top-six stocks with a weight of 34 percent in the Nifty-50 index have delivered negative returns over the past two years. Similarly, 22 stocks with a weight of 55 percent in the Nifty-50 index have given less than 10 percent returns over the past two years, it added.
The Nifty-50 index is up 9.8 percent, the BSE Midcap index is up 24 percent and the BSE Smallcap index is up 29 percent over the past two years.
Going ahead, the brokerage finds much better value in the top large-cap stocks (most of the top 15-20 stocks by market cap) and expects them to outperform in the next 6-12 months, as the current euphoria in other large, mid-and small-cap stocks may fade over time and their valuations realign with their fundamentals.
In addition, increased global (higher-for-longer interest rates) and domestic (economic, political) risks would warrant more caution, warned Kotak.
Apart from the top large-cap stocks, the brokerage mentioned that it does not find much value in other large-cap and mid-cap stocks given (1) rich valuations in general and (2) disruption threats in the consumption sectors.
It expects most of these stocks to go through time correction over the next several months (years also in some cases). The market has largely focused on short-term positive narratives of (1) large order inflows in the case of the investment sectors while ignoring the medium-term challenges of sustainability of order inflows and uncertain execution and profitability and (2) increase in gross and EBITDA margins in the case of consumption sectors while ignoring the short-term risk of volume challenges and the medium-term risks of emerging threats to the business models of incumbents, explained the brokerage.
It also advised investors to stay away from mid-cap and small-cap stocks given that most stocks are trading well above or near 12-month target prices. The better-quality stocks may see time correction, while plenty of lower-quality mid-and small-cap stocks (within and outside our coverage) could see large prices or lengthy periods of time correction, it forecasted.
Last month, the brokerage dropped its recommended mid-cap portfolio since it could not find too many stocks beyond the BFSI (banking, financial services, and insurance) space that offer decent potential upside to its 12-month fair value.
"We see a limited point in trying to find fundamental reasons behind the steep increase in stock prices of several mid-cap. and small-cap. stocks. There is no meaningful change in the fundamentals of most companies; in fact, they have worsened in many cases. The primary driver of the rally appears to be irrational exuberance among investors, with high return expectations (and purchase decisions) being driven by the high returns of the past few months," explained the brokerage as the reasons behind this decision.
Portfolio changes
The brokerage has included Colgate Palmolive (CLGT) and Cummins India (KKC) in recommended portfolio, with a weight of 150 bps each and reduced positions in Axis Bank (35 bps to 7.2 percent), M&M (40 bps to 200 bps) and Titan (60 bps to 150 bps).
It has also removed Samvardhana Motherson as the stock has delivered a 37 percent return in the past six months and offers a moderate upside to its 12-month fair value of ₹105. However, the brokerage continues to like the company’s fundamentals and long-term prospects, but sees near-term headwinds to global automobile volumes from global growth challenges.
Both Colgate and Cummins used to be in Kotak's erstwhile mid-cap. recommended portfolio, added the brokerage.
