One good outcome of the crash in Indian equities is that relative valuations of mid- and small-cap shares have fallen to their rightful place. In January, the price-earnings multiple of the Bombay Stock Exchange’s (BSE) mid-cap index was nearly as high as that of the Sensex. And the BSE small-cap index traded at only an 18.5% discount to the Sensex.
Based on Friday’s close, both indices trade at a 27% and 50% discount to the Sensex, respectively. Ditto with the Nifty Junior index and the CNX Midcap, published by the National Stock Exchange, which now trade at a 28.8% and 35.5% discount to the Nifty, compared with discounts of 4.5% and 9%, respectively, in January.
Current valuations better reflect the higher risk investors in smaller firms face vis-a-vis the blue-chip companies comprising the Sensex. But it’s also important to note that the smaller firms had generated much higher returns for investors during the bull run between April 2003 and January 2008. These indices offered compounded annual returns of as high as 62% and 63.3%, respectively, until January this year. For investors who stuck to blue chips represented by the Nifty, the return between April 2003 and January 2008 was lower at 47.4%.
Also see Mixed Trend
After the sharp correction since January, however, the outperformance of these indices in terms of annual returns has also fallen sharply. While the Nifty has generated compounded annual returns of 22.8% between April 2003 and October 2008, those of the Nifty Junior and the CNX Midcap index stand at 26.4% and 30%, respectively. The relatively narrow difference makes one wonder whether it’s worth taking the risk associated with mid- and small-cap stocks. After all, if the bearish phase continues, the differential could narrow further.
Needless to say, the above results are based on market indices and may not be true across all stocks and sectors. There would well be some mid- and small-cap stocks that have generated much higher returns. Still, the onus of booking profit at the right time seems to be much more on mid-cap investors, compared to those who stick to large-cap stocks.