Mid-caps: Best bet for investors in turbulent times

The last three years have been challenging times for the mid-cap stocks. However, important thing to note here is that this is not alien to the concept of mid-cap investing.

Midcaps over the period have always gone through such volatility. The Nifty and the broader markets have corrected meaningfully from the recent highs, led by deepening economic slowdown, weak corporate earnings growth and certain policy decisions in the budget on taxation.

India’s (BSE-500) market capitalisation is down 11% from its peak of Rs 148 lakh crore in August 2018. Over the same period, the market cap of the Nifty-50 is down by 6% to Rs 80.1 lakh crore, NSE mid-cap 100 by 17% to Rs 14.3 lakh crore and NSE small-cap by 15% to Rs 4.4 lakh crore.

There is a rush for ‘flight to safety’ since December 17, with investors taking refuge in quality large-cap names amidst heightening volatility. The common conviction seems to be ‘The bigger the better’ if we look at the timelines when different indices reached their peak market-caps.

Market-cap of small-caps peaked in December 2017, mid-caps in January 2018 and the Nifty in May 2019. Nifty trades at a 12-month forward price-equity (P/E) of 17.6x, near its 10-year average of 17.9x.

The Nifty Midcap100 P/E has corrected from 25.6x in August 2018 to 14.3x currently. Mid-cap premium to the Nifty (14% in August 2018) has now turned into a discount of 19%, clearly underscoring the sharp underperformance of mid-caps versus the benchmark.

As a consequence, the five-year compound annual growth rate (CAGR) returns of the Nifty-50 and Nifty-Midcap have converged. The Nifty and Nifty Midcap Index have the same five-year CAGR returns, now.

In March 2018, the five-year CAGR returns for Nifty Mid-cap stood at 20% and for Nifty at 12% (implying returns over March 2013 and March 2018). So in a nutshell, the investor is back to the place where he was five years ago. It implies that someone allocating fresh investment in Midcaps can make immense wealth creation opportunities in the coming years.

It is always better to enter small and mid-cap space in the bear market. I believe there is a lot of noise on slowdown in the economy, but remember one thing big noise only comes at the bottom. We have a lot of cleaning up activity has happened over the past some time. The regulators have been working proactively.

We have lot of midcaps again trading at insane valuations. Also, a lot of them are with low debt and good dividend yield, higher Return on Capital Employed over Return on Equity (ROCE /ROE). Going forward I believe if we look at the broader picture and the improving macroeconomic indicators, lower interest rate regime, lower crude oil prices, good monsoon across India augurs well to fuel the economy.

Also, the recent announcement of spending on Infrastructure and rolling back of surcharge on Foreign Portfolio Investors (FPI), open market operations (OMO) by RBI and infusing capital in PSU banks have been a very positive impact on markets. RBI and Finance Ministry are in sync to make India an investment magnet and $5-trillion economy. Also most importantly, the government’s focus to revive the SME and MSME sectors, along with tax benefits given to smaller and midsize companies in the current budget, augurs well for the markets.

This simply indicates the major winner in coming months will be midcaps and microcap. Just to give you a perspective that it has been always so that an investor creates wealth if invested in turbulent times.

Mid-caps hold the potential to generate higher returns than large-cap, as they are in a better position to take advantages of economic recovery when it happens. Mid-cap, small-cap stocks are like wine and give the best results when owned for long periods. Happy investing!