BackMid-caps reach new high, but it’s now time for caution
As with all mid-cap rallies, even companies with weak fundamentals can ride piggyback on the performance of stocks which have good fundamentals
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Mid-cap and small-cap stocks are on a roll. BSE’s Mid-cap index hit a new all-time high in intraday trading on Wednesday and its Small-cap index reached its highest levels since January 2008. What’s more, as a composite, valuations of the Mid-cap index are at almost a 50% premium compared with the BSE 100, an index made up of the largest companies by free float market capitalization.
Of course, one can argue that these valuations based on trailing earnings can skew the picture, since mid-caps tend to grow at materially higher rates than large companies. The differential won’t be as high using forward earnings, the argument goes. But note what analysts at Credit Suisse Securities (India) Pvt. Ltd say in a recent report titled Little India: relative valuations of mid-caps are at a 10-year high. The brokerage firm had said in an earlier note that even though “the forward price-earnings valuation premium may not be as excessive, the trailing ratio suggests reason for caution".
That report also highlighted an indiscriminate rise in the valuations of mid-caps—less than a tenth of all mid-caps studied had negative returns in the preceding year. These stocks are rising en masse. It seems safe to say that a mid-cap bubble has formed.
It’s important to note, however, that the stupendous rise in some mid-cap stocks such as VA Tech Wabag Ltd has been supported by underlying fundamentals.
One can argue that the rally may have gone a bit far, but there’s no denying that decent growth prospects have attracted investors to some such companies. In some cases such as mid-cap pharma stocks, there’s been a structural shift, with institutional investors increasing pharma exposure in tandem with the increase in the weight for the industry in MSCI’s indices.
But as with all mid-cap rallies, even companies with weak fundamentals can ride piggyback on the good performance of stocks which have good fundamentals. And as is the norm, this will end in misery for those who are merely riding the wave.
The writer doesn’t own shares in the above-mentioned companies.
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