Even though the selloff in the market has been broad-based, mid and smallcaps have been suffering more of late compared to their larger peers as investors prefer relatively stable largecap stocks in the uncertain market.
Data show that BSE Midcap and Smallcap indices have fallen 11 percent each in this calendar year till May 10 closing against a 7 percent fall in equity benchmark Sensex.
In recent times, when the market has so many headwinds to deal with, investors are extremely cautious about equities and trying to stick to largecaps with strong fundamentals and attractive valuations.
Why are mid, smallcaps underperforming?
In a bearish phase of the market, investors tend to prefer quality stocks that have significant market share and have the ability to withstand knee-jerk reactions of the market. Besides, in times of declining economic growth, largecaps outperform mid and smallcaps.
In the current uncertain times, given rising inflation, higher commodity prices and tightening monetary policy, largecaps are better placed.
"We believe large caps are better placed to handle the situation due to scale and better pricing power. On the softer side, in a falling market investors sells mid and small cap stocks faster to avoid liquidity issues later," said Shrikant Chouhan, Head of Equity Research (Retail), Kotak Securities.
The underperformance of mid and smallcap stocks has been led by weak global cues, with concerns around inflation and potential rate hikes sparking a risk-off globally, leading to elevated FII outflows from India, Sneha Poddar, AVP Research, Broking & Distribution, Motilal Oswal Financial Services, underscored.
She added that, while the Nifty has not seen much earnings downgrade so far, the broader universe is clearly bearing the brunt of commodity cost inflation – a trend we saw even in Q3FY22 corporate earnings season.
Amit Gupta, Fund Manager- PMS, ICICI Securities raised an important point that the current earnings yield gap of largecaps and midcaps is lower than 50 bps. This is where largecaps look more attractive vis-a-vis midcaps. However there are many sectors like textiles, sugar, paper, chemicals, etc., where only midcaps are present and thus they may see good traction, said Gupta.
Can mid, smallcaps continue to underperform?
Many analysts are of the view that mid and smallcaps can suffer more in the near term due to prevailing uncertainty.
Chouhan feels a lot more pain may be in the offing for small and mid cap stocks and investors need to be selective.
"We believe that it is extremely important to understand the current business and its potential going forward before investing in small and mid-cap stocks. Get into businesses where demand is strong, pricing pressure is low and the entry barrier is high," said Chouhan.
Poddar of Motilal Oswal highlighted after the recent correction, that the Nifty is now trading near its 15-year long-term average of about 18 times while midcaps are trading in line with the Nifty.
She believes the weakness in the market may persist till the concerns over inflation, rising interest rates, and prolonged Russia-Ukraine war subsides. But still, this correction has offered the opportunity to accumulate some good quality stocks from a long-term perspective, Poddar added.
Stocks to buy
Analysts believe it is the right time for staggered bottom fishing in the mid and smallcap segment as the Ukraine war poses only a short-term headwind for domestic equity markets and markets globally will stablise after the geopolitical tensions ease and clarity on the magnitude of rate hikes emerge.
"The earnings of Nifty50 from FY21 to FY23 is expected to grow at a CAGR of about 24.4 percent. The next 12-month target for Nifty50 is 18,900. The bull market that started in 2020 is not yet over. While there are challenges from global factors and inflation, India’s medium to long-term economic growth outlook remains strong on the back of an expected multi-year investment cycle, where any meaningful correction should be taken as a buying opportunity to enter into quality stocks," said Siddharth Sedani - Vice President, Equity Advisory, Anand Rathi Shares and Stock Brokers.
Sedani has 'buy' calls on CRISIL, Garware Technical Fibres, Jubilant Ingrevia, Intellect Design Arena and Federal Bank.
Chouhan said one should focus on companies that are gaining market share or have strong order-book which give decent revenue visibility and can handle margins well.
"From a long-term perspective, investors can look at Mphasis, Jindal Steel & Power, Aegis Logistics, Sumitomo Chemical India, and IndiaMart," said Chouhan.
Gupta of ICICI Securities underscored stocks from spaces like agro-chemicals, paints, telecom, sugar, capital goods and banks are likely to recover fast post the recent market volatility and these sectors may be considered for investment at this juncture.
"Aggregate credit growth in banks in last two quarters has increased to 9.5 percent which is on account of continued public capex as well as initiation of private capex also in certain sectors. In addition, higher crop prices would provide a tailwind to the farming sector and revival in home registrations would drive the entire building materials space," said Gupta.
Akhilesh Jat, an analyst at CapitalVia Global Research said one should go for midcap IT stocks which have a solid track record of delivery on the financial front.
Moreover, high food prices are in favour of farmers which may help revive tractors as well as two-wheeler demand in rural areas which is a positive for the automobile sector. Trident, Mphasis, Escorts and GNFC are the stocks that can give good returns in a one-year time frame, said Jat.
Poddar has 'buy' calls on Varun Beverages, Cholamandalam Financial Holdings, Indian Hotels and Transport Corporation of India.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies and not of MintGenie.