Hold on, midcaps still have some steam left
The midcap party is still on with valuations in the segment climbing following the recent uptick in the stock market. While frontline indices like the Nifty and the Sensex are still some way off their all-time highs, other indices such as the BSE Midcap and BSE Smallcap are both trading at near all-time highs. Should investors pare their exposure to this segment or are they missing the big picture?
INDEX VALUATIONS DISTORT PICTURE
While the BSE Sensex has surged 8.2% over the turn of the year, the BSE Midcap has gone up by 12.5%. Which means the BSE Midcap is now trading at a 34% premium to the BSE Sensex.
However, experts say investors are missing the broader picture by focusing on the broader PE (price-to-earnings) multiples in this segment.
“Many of the companies constituting the index have depressed earnings or even negative earnings, which is artificially boosting the PE multiple for the entire index,“ argues Vikas Gupta, chief investment strategist, OmniScience Capital. This gives the impression that valuations for the entire basket are high.
Lalit Nambiar, fund manager-equity , UTI Mutual Fund, says the midcap index is not representative of the broader midcap basket, and it would be a mistake to assess opportunities on index valuations alone. “Index components are typically well researched ideas with high analyst coverage, particularly in the larger midcap names. But the alpha comes from the yetto-be discovered names from the segment,“ he explains.
He points out that the midcap basket mostly comprises of cyclicals, whose earnings fluctuate too much to make price-earnings multiples a meaningful valuation metric. They also trade at higher price-earnings multiples when they are in a cyclical downturn, possibly near the bottom of the cycle.
Given these, Nambiar believes that midcaps are not nearly as expensive as they are made out to be.
While fund managers admit that it is becoming difficult to find quality stocks at the right valuations, they insist that opportunities still exist for investors to enter this segment.
Gupta reckons that a large part of the midcap space is fairly valued on a price-to-book value basis. Indeed, at a price to book value multiple of 2.4 times, the BSE Midcap index is on par with its 10 -year historical average, which suggests that fur ther scope for ap preciation ex ists.
“Investors should consider deploying money over the next six months, as later on it will be difficult to get entry into the right stocks once the market gets clarity on the earnings sit uation,“ adds Gupta.
It is best to avoid companies that are leveraged and stick to quality names where the price-book value ratio is moderate.But he cautions investors against opting for the obvious quality picks that are among the market favourites, where they will end up overpaying.
Select stocks in IT, pharmaceuticals and auto ancillaries provide enough opportunities in this segment, Gupta says. Specialised players in the public sector NBFC also gets a thumbs up.“Don't take concentrated bets in the midcap segment as we have seen instances of blow-out in some companies,“ cautions Nambiar who suggests that investing in a mid-cap oriented equity fund is better.
WHAT FUND INVESTORS SHOULD DO
While the midcap space continues to hold promise, experts are wary of valuations in the small cap segment.This is clear from the recent actions by funds which were focussed on this basket.
DSP BlackRock Micro Cap has suspended further subscriptions into its scheme, Canara Robeco Emerging Equities has altered its fundamentals attribute, changing the investment focus to midcaps after valuations in smallcaps soared over the past year.
Mirae Asset Emerging Bluechip Mirae Asset Emerging Bluechip had also stopped accepting lump sum subscriptions last year. For mutual fund investors who have benefited from exposure to the midcap and small cap equity segments, financial planners suggest realigning the portfolio in favour of the midcaps, and even some largecaps.
INDEX VALUATIONS DISTORT PICTURE
While the BSE Sensex has surged 8.2% over the turn of the year, the BSE Midcap has gone up by 12.5%. Which means the BSE Midcap is now trading at a 34% premium to the BSE Sensex.
However, experts say investors are missing the broader picture by focusing on the broader PE (price-to-earnings) multiples in this segment.
“Many of the companies constituting the index have depressed earnings or even negative earnings, which is artificially boosting the PE multiple for the entire index,“ argues Vikas Gupta, chief investment strategist, OmniScience Capital. This gives the impression that valuations for the entire basket are high.
Lalit Nambiar, fund manager-equity , UTI Mutual Fund, says the midcap index is not representative of the broader midcap basket, and it would be a mistake to assess opportunities on index valuations alone. “Index components are typically well researched ideas with high analyst coverage, particularly in the larger midcap names. But the alpha comes from the yetto-be discovered names from the segment,“ he explains.
He points out that the midcap basket mostly comprises of cyclicals, whose earnings fluctuate too much to make price-earnings multiples a meaningful valuation metric. They also trade at higher price-earnings multiples when they are in a cyclical downturn, possibly near the bottom of the cycle.
Given these, Nambiar believes that midcaps are not nearly as expensive as they are made out to be.
While fund managers admit that it is becoming difficult to find quality stocks at the right valuations, they insist that opportunities still exist for investors to enter this segment.
Gupta reckons that a large part of the midcap space is fairly valued on a price-to-book value basis. Indeed, at a price to book value multiple of 2.4 times, the BSE Midcap index is on par with its 10 -year historical average, which suggests that fur ther scope for ap preciation ex ists.
“Investors should consider deploying money over the next six months, as later on it will be difficult to get entry into the right stocks once the market gets clarity on the earnings sit uation,“ adds Gupta.
It is best to avoid companies that are leveraged and stick to quality names where the price-book value ratio is moderate.But he cautions investors against opting for the obvious quality picks that are among the market favourites, where they will end up overpaying.
Select stocks in IT, pharmaceuticals and auto ancillaries provide enough opportunities in this segment, Gupta says. Specialised players in the public sector NBFC also gets a thumbs up.“Don't take concentrated bets in the midcap segment as we have seen instances of blow-out in some companies,“ cautions Nambiar who suggests that investing in a mid-cap oriented equity fund is better.
WHAT FUND INVESTORS SHOULD DO
While the midcap space continues to hold promise, experts are wary of valuations in the small cap segment.This is clear from the recent actions by funds which were focussed on this basket.
DSP BlackRock Micro Cap has suspended further subscriptions into its scheme, Canara Robeco Emerging Equities has altered its fundamentals attribute, changing the investment focus to midcaps after valuations in smallcaps soared over the past year.
Mirae Asset Emerging Bluechip Mirae Asset Emerging Bluechip had also stopped accepting lump sum subscriptions last year. For mutual fund investors who have benefited from exposure to the midcap and small cap equity segments, financial planners suggest realigning the portfolio in favour of the midcaps, and even some largecaps.
