June quarter results are not easily comparable on a year-on-year basis due to the change in accounting standards for non-financial companies from 1 April 2016. Even so, on a relative basis, small-sized firms remain laggards vis-à-vis large and medium-sized companies.
This is interesting especially in light of the ongoing rally in mid- and small-cap stocks. Of course, while there will be a variance in the performance of different companies and sectors, as a category, small firms have done quite poorly.
The chart shows net sales and operating profit growth of listed companies in the June quarter. Banks and financial institutions have been left out because their businesses are very different and they have been affected by the clean-up of bad loans started by the Reserve Bank of India (RBI). Firms in the oil and gas sector have been excluded because of the volatility in their earnings.
These non-bank, non-oil firms have been divided into six categories based on the size of their revenues. As the chart shows, the growth in net sales and operating profits for small-sized firms has been dismal in the June quarter. Firms with net sales of below Rs100 crore reported a 12.3% decline in revenues on a cumulative basis, while companies with net sales of over Rs1,000 crore reported a 2.1% growth in revenues.
The subdued performance of smaller firms is also reflected in bank credit data. Latest RBI data shows that bank credit to large industrial units grew on a year-on-year basis while that to medium and micro and small industrial units declined.
Despite the unimpressive earnings performance, many mid-cap and small-cap stocks are trading at expensive valuations after the sharp run-up that they have seen this year. But that, according to some experts, is largely driven by the underlying bullish sentiment in the market rather than these firms’ earnings.
According to a recent Kotak Institutional Equities report, earnings will become more relevant as the effects of global and domestic macro factors fade. Domestic positive events such as implementation of the seventh pay commission recommendations, a good monsoon and a decline in interest rates have partly played out but are largely priced in, and the market’s focus is likely to shift increasingly to earnings and fundamentals as the scope for re-rating of multiples is quite limited, the report said.
As such, investors should be increasingly cautious about riding the mid- and small-cap rally blindly.