Mumbai: Mid-cap stocks have outpaced the benchmark Sensex and Nifty indices for the fourth year in a row, beating concerns over valuations and fundamentals.
This year so far, the BSE Midcap index rose 46.07% and BSE Smallcap jumped 57.65%, while the Sensex and Nifty have rallied 27-28%. Both BSE Midcap and BSE Smallcap indices touched 17,653.68 and 19,053.91 on Friday for first time, while Sensex and Nifty also hit new highs.
According to Saurabh Mukherjea, chief executive officer of Ambit Capital Pvt. Ltd, there is growing evidence that key large-cap indices in India are no longer able to fully benefit from the country’s economic growth, pushing investors towards less liquid mid- to small-cap stocks.
“As the bull market gathers momentum, we find clear evidence that below the BSE500, the stocks with the weakest fundamentals are running up the most. Anecdotal evidence suggests that these stocks are being ‘squeezed’ by groups of well-informed and well-capitalized high net worth (individuals) who are using social media effectively. Ironically, small cap companies with strong fundamentals haven’t run up as much as the weaker names partly because speculators have left these names alone,” he said in a note on 19 December.
Deepak Jasani, head, retail research, HDFC Securities, said that mid and smallcap stocks are nimble-footed and adjust quickly to the changes. “Most of these small firms have undergone changes like asset value unlocking, mergers etc which have opened up growth opportunities. Also, float of these stocks is not high and institutional holding in these companies is also not high. Even if the price has moved ahead of fundamentals, investors have not yet booked profit in anticipation of higher returns,” Jasani added.
With little fundamental support amid continuous earning downgrades, valuations appear steep as the premium of the BSE Midcap index to the Sensex is widening (climbing to 35.4% on 10 December).
At current levels, the BSE Midcap is the most expensive index with one-year forward price-to-earnings (PE) ratio at 28.39, while the Sensex is available at 20.83 and the BSE Smallcap at 23.50. However, earnings estimates have been on a slippery slope. According to Bloomberg estimates, since the beginning of FY17, BSE Midcaps’ expected earnings for the current fiscal and the next have been slashed by 26.86% and 15.6%, respectively. Similarly, for Sensex, earnings for FY17 and FY18 have been cut by 11.3% and 4.4%, respectively.
Mukherjea said, “It is evident that companies with questionable fundamentals are seeing heavy trading and rapid upward price movement. Several of these companies’ share price development over the past year has a pattern.”
According to him, institutional investors, who are receiving rapid inflows, start bidding for the stock and with the free float cornered by a small clique, the stock price gets squeezed. “This leads to more retail buying and the “virtuous cycle” of higher volumes and higher prices sets in. This phenomenon is resulting in capital being channeled into suspect companies,” he added.