There is a classic debate going on among market participants whether one should buy mid and small cap stocks in this market or just focus on the large caps that are considered relatively stable in volatile times.
In this calendar year so far, mid and small cap indices have fallen more than the benchmark Sensex. While the Sensex has retreated 5 percent, BSE Midcap and Smallcap indices have fallen 7 percent and 9 percent, respectively, in the year so far.
The recent selloff in the market has brought the valuation of large caps to multi-month low levels. Brokerages point out that a key valuation matrix, price to earnings (PE) ratio of Sensex is at 24.23 currently which is the lowest since July 2020. The Nifty is now trading at 19 times 12-months forward PE, which is slightly lower than its 10-year average for the first time since November 2020.
As uncertainty prevails and the near term outlook of the market is hazy, investors are trying to figure out what to buy and what to leave in this market.
Large cap vs mid and small caps
Analysts find little merit in this debate and point out that no stock is fall-proof. While large companies do have the advantage of a strong balance sheet and wider market share, there are also decisive factors such as corporate governance, debt and growth prospects. Besides, the importance of the economic cycle cannot be undermined.
"We advise investors not to try catching the falling knife. Instead of trying to choose stocks from the broader market indices, investors should try to choose quality stocks with healthy financial data and strong prospects," said Likhita Chepa, Senior Analyst at CapitalVia Global Research.
However, the valuation comfort after the recent fall may play in favour of the large caps in the short term.
"We expect large caps to outperform the mid and small caps in the coming period as valuations have cooled down and are attractive now," said Chepa.
So, risk-averse and conservative investors may prefer to stick to large caps amid heightened volatility but a blind bet should be avoided and only select stocks from a few pockets should be bet on.
"In this highly volatile market exposed to heightened uncertainty, safety is in large-caps, particularly in segments like IT and metals," said VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.
However, Vijayakumar added there are many resilient mid and small caps that are immune to FPI selling since FPIs don't hold these stocks. "Stocks in entertainment, quick service restaurants, etc., that are doing well from opening up should be held on to," said Vijayakumar.
The ongoing Russia-Ukraine war has put the market in uncertain territory. There is a lot of volatility and every gain in the market is followed by a strong wave of a selloff. Analysts point out that mid and small caps are more vulnerable to selloffs.
"The Street is in the fear zone on escalating Russia-Ukraine war which is going to push global inflation higher, but all eyes are now on the second round of peace talks between Russia and Ukraine very soon. Hence, we expect the underperformance in mid-and small-cap segments would continue for a few more weeks until we get some clarity from the Russia-Ukraine war field," said Prashanth Tapse, Vice President (Research), Mehta Equities.
"We believe catching bottoms is a bit difficult task to predict at the current juncture, but a meaningful 10-15 percent correction from here, a lot of mid and small caps quite attractive for long term. Hence we advise conservative investors to deploy and accumulate best in class quality mid and small caps in a phase-wise manner keeping only long term investment goals," said Tapse.
Despite the fact that large caps have the advantage of size and market share, the answer is not to avoid the mid and small caps but bet on quality stocks.
“Large caps are considered relatively stable than the mid and small caps in a volatile market but it does not mean that the large cap stocks are fall-proof. Instead of choosing between large cap and mid and small caps, one should focus on quality stocks across segments that are fundamentally strong and can withstand and prosper in these disruptive times" said Deepak Jasani, Head of Retail Research, HDFC Securities.
