ETMarkets Diwali survey: Midcaps, smallcaps set to outperform over next one year

Mumbai: Midcap and smallcap stocks are poised to outperform the frontline indices over the next one year, as economic activity picks up gradually and earnings growth is expected to show some momentum, majority of the analysts polled in an ETMarkets.com survey showed.

However, stock picking in this space would be key, and one would need to separate the wheat from the chaff.

BSE midcap and smallcap indices have been shedding value and underperforming the benchmark Sensex since 2018.

BSE Midcap index dropped 13.38 per cent in 2018 and 3.05 per cent in 2019, and is flat for this year till now. Meanwhile, BSE Smallcap Index declined 23.53 per cent in 2018, 6.85 per cent in 2019, and is down 0.3 per cent for this year. In comparison, benchmark Sensex rose 6.91 per cent in 2018 and 17.36 per cent in 2019 and 4.57 per cent so far this year.

Out of the 97 components of the BSE Midcap index, 48 have shed weight on a year-to-date basis, while 343 of the 675 BSE Smallcap Index have declined so far this year.

“We expect midcaps and smallcaps to outperform largecaps over the medium term, as is generally the case at the early stage of economic recovery,” said Nirav Sheth, Chief Executive Officer, Emkay Institutional Equities.

“Secondly, the valuation gap between largecaps and mid/smallcaps favours the latter,” Sheth said.

He says smallcap companies with an identifiable MOAT and those addressing a large market will have an edge to transit into a large company, and companies such as Dixon Technologies and Amber Enterprises have a big opportunity to exploit.

While Sensex rules at record high, BSE midcap and smallcap indices are 18 per cent and 33 per cent away from their all-time highs of 18,321 points and 20,183, respectively.

Binod Modi, Head of Strategy at Reliance Securities, said midcaps and smallcaps have underperformed in last two years, as ambiguity over earnings recovery hurt them.

“Going forward, sustainability of the recent pickup in economic activity may result in strong outperformance from midcaps and smallcaps,” Modi said.

“In our view, a sharp earnings recovery will not be broadbased due to fiscal constraints and absence of sharp revival in capex cycle. In short, men will get separated from the boys in the midcap and smallcap space over next one year,” he added.

G Chokkalingam, Founder of Equinomics Research and Advisory, says value stocks in the midcap and smallcap space could be the biggest investment themes for next one year.

Going by estimates, India’s absolute GDP level in FY2022 is expected to be less than what it was in FY2020 as it is expected to shrink about 10 per cent in FY2021, but grow 6-8 per cent in FY2022.

Chokkalingam said leaders across sectors because of dominant business sizes would find it difficult to maintain significant growth momentum next year, as most of them trade at huge valuation multiples. They would make way for the smallcap and midcap segments in 2021.

“Going by history, in a 3-4 year kind of time frame, the SMC (small-midcap) segment outperforms largecaps substantially, largely because attractive relative valuations,” he says.

AK Prabhakar, Head of Research at IDBI Capital Markets, sees promise in midcap and smallcap stocks such as Sumitomo Chemical India, VBC Ferro Alloys, Bayer Cropscience, Coromandel International, Alembic Pharmaceuticals, SBI Cards & Payments and Nippon Life Asset Management. Among these, he believes Sumitomo Chemical has the potential to become a largecap over next 5-10 years.
Not everyone is so upbeat on midcaps and smallcaps, though.

Gaurav Garg, Head of Fundamental Research at CapitalVia, says largecaps will improve over the next year, as the current market recovery cycle is completely different from what was seen previously in terms of factors that influenced the market crash followed by recovery.

“It will take a longer time to restore the damage caused to the midcap to smallcap businesses than a largecap company,” he argued.

Rusmik Oza, Executive Vice-president (head of fundamental research - PCG), Kotak Securities, prefers economy-driven largecaps and smallcaps to midcaps with a one year purview.

“Since smallcaps are an ocean in terms of number of stocks, there will be many bottoms-up stock-picking opportunities over there,” he said.

“Most of the economy-driven large caps have grossly underperformed Nifty50 in last one year. Hence, we can expect them to play catch-up over next one year and outperform the benchmark index,” he said.