India's mid and small cap stocks risk abrupt corrections, warn analysts

Motilal Oswal Financial Services

21/06/2023 11:21

By Bharath Rajeswaran
       BENGALURU, June 21 (Reuters) - A roaring rally in mid-
and small-cap stocks listed on Indian bourses could see abrupt
corrections, as many of them trade at near or record highs even
though overall consumption demand remains sluggish, at least six
analysts said. 
    The Nifty mid-cap 100 index  .NIFMDCP100  has hit fresh
all-time highs in each of the previous seven sessions, gaining
19% so far in fiscal year 2024, while the small-cap index
 .NIFSMCP100  touched new 52-week highs over the last seven
sessions and added 20% year to date.
        In contrast, the benchmark BSE Sensex and the NSE Nifty
have gained 7.7% and 8.6% in the same period, respectively.
  
        "The sharp rally in mid and small caps seem to be
bordering on euphoria as consumption demand remains sluggish and
valuations have reached unrealistic levels in most cases,"
analysts at Kotak Institutional Equities wrote on Monday.
    Growth in the Indian economy is seen slowing to 6.5% in the
current financial year compared to 7.2% last year. In the
Jan-March quarter - the latest data available - private
consumption grew just 2.8% even as government spending boosted
the broader economy. Weaker demand could weigh on company
earnings.
        Others warned of erratic monsoons, which can impact
India's largely agriculture-based economy.
  
    "Nothing is cheap right now, so investors have to be very,
very selective on midcaps," said Avinash Gorakshakar, head -
research at Profitmart Securities. "If monsoon is not as per
expectations, we could witness a temporary halt in the rally."  
    The 12-month forward price-to-earnings ratio - a metric that
measures valuation of an index or security - of the mid-cap
index  .NIFMDCP100  stood at 24.1 on June 20, while the Nifty
50's  .NSEI  P/E ratio was 21.9. The P/E ratio for the small-cap
index  .NIFSMCP100  was just below at 19.6. 
    The P/E ratio of midcap index has risen from 23.5 at the
start of the year to 24.02 in June while the P/E ratio of
smallcap index rose from 16.39 in January to 19.6, amid the
rally in markets.   
    Most mid-cap stocks are also trading well above their
pre-Covid multiples. 

    DOMESTIC DEMAND
    A strong inflow of funds from domestic investors has been
instrumental in pushing up valuations.
    Since January 2022, mid-cap equity-oriented schemes and
small-cap schemes saw inflows of 286 billion rupees ($3.49
billion) and 318.91 billion rupees respectively, twice as much
as the 143.45 billion rupees invested into large-cap schemes,
data from the Association for Mutual Funds in India showed.
    The interest in this set of stocks has prompted fund house
Motilal Oswal to launch India's first-ever micro-cap index fund
for investors looking beyond the Nifty 500 firms for hidden
opportunities.
    "Large caps can absorb that much of liquidity, but when
midcaps start attracting that kind of flow, then it becomes
difficult to absorb liquidity and valuations will get re-rated,"
said Hemant Kanawala, head - equity investments, Kotak Life
Insurance. 
   One 97 Communications  PAYT.NS , Aurobindo Pharma  ARBN.NS ,
PB Fintech  PBFI.NS  have been among the top mid-cap performers
in 2023, adding over 40%.
    To be sure, not everyone is skeptical about the recent
rally.
    "Post the correction in global equities in 2022, the rally
in Indian markets has been more broad-based and has trickled
down to midcaps," said Atul Suri, chief executive officer at
Marathon Trends Advisory.
    Suri expects the rally in broader markets to continue, led
by the revival in the industrial cycle. He identified inflation
as the major lingering risk to the Indian market rally.
    


($1 = 81.9878 Indian rupees)

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Price to earnings ratio of key indexes    https://tmsnrt.rs/3NCqiat
Top midcap gainers and losers in 2023    https://tmsnrt.rs/3PmJ4nI
Midcap, smallcap schemes see more inflows than largecaps    https://tmsnrt.rs/46hLp9F
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 (Reporting by Bharath Rajeswaran in Bengaluru; Editing by
Dhanya Skariachan and Nivedita Bhattacharjee)
 ((bharath.rajeswaran@thomsonreuters.com; +91 9769003463;))