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Business News/ Markets / Stock Markets/  Sensex narrows valuation gap with midcaps as big stocks rally
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Sensex narrows valuation gap with midcaps as big stocks rally

Market watchers said while it is unlikely that mid-caps—which typically rise and fall faster than large-caps—will lose favour with investors, valuations remain stretched as smaller stocks suffer from depressed earnings while larger firms with superior financials survive the pandemic impact

The benchmark S&P BSE Sensex rose 0.28% to 47,746.22, while the NSE Nifty 50 index ended 0.35% higher at 13,981.95.mint (HT_PRINT)Premium
The benchmark S&P BSE Sensex rose 0.28% to 47,746.22, while the NSE Nifty 50 index ended 0.35% higher at 13,981.95.mint (HT_PRINT)

The valuation premium enjoyed by mid-cap stocks during much of 2020 has shrunk, as better earnings and financials drive up stocks of their large-cap peers. The Midcap index’s highest FY21 valuation premium of 38% to the Sensex has since contracted to a mere 6% in March.

According to Bloomberg data, the BSE Midcap index now has a one-year forward price-to-earnings (PE) ratio of 24.1 times, against 22.75 times for the Sensex. The premium was the highest on 28 September, when the BSE Midcap and Sensex PEs were at 27.48 and 19.96, respectively.

Market watchers said while it is unlikely that mid-caps—which typically rise and fall faster than large-caps—will lose favour with investors, valuations remain stretched as smaller stocks suffer from depressed earnings while larger firms with superior financials survive the pandemic impact.

“There are multiple reasons for the premium shrinking. The first is—large-caps have also done reasonably well with value stocks outperforming the growth stocks. Also, post the quarterly results, we have seen significant earnings upgrades. This has also resulted in the valuations becoming cheaper. Thus, putting these two factors in perspective, the mid-cap valuation versus the large-cap, has shrunk," said Naveen Kulkarni, chief investment officer, Axis Securities.

Turning tide
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Turning tide

However, Kulkarni said mid-caps still look attractive and may bounce back with time. During the bull market phase of 2017, mid-cap valuations were at a 45% premium to large-caps. The recent spate of IPOs and their success indicate the appetite for mid- and small-cap stocks, and these are likely to see stronger earnings growth with the economy rebounding, he said.

After the rally in FY17, mid-cap valuations have largely remained subdued, significantly underperforming the Sensex. However, in FY21, the BSE Midcap index has gained 98%, outpacing the 72% rise of Sensex. From its March lows, the BSE Midcap index surged 103% while the Sensex gained 88%. However, in FY19 and FY20, BSE Midcap was down 3% and 32%, respectively.

According to Niket Shah, fund manager at Motilal Oswal AMC, a strong liquidity environment and rebound in the economy have helped mid- and small-cap stocks. “Hence, headwinds fading itself should deliver a strong bounce in mid-caps. With nominal prices going higher, it will improve mid-cap companies’ operating leverage. Mid-caps still have a lot of catch-up to do," Shah said.

FY22 earnings estimates of mid- and small-cap stocks ranked 100th-650th by market value plunged in April-June 2020, bottomed out in September, and have seen consistent upgrades since then. From the market’s perspective, it’s this earnings outlook upgrade that has been at play, said analysts at Edelweiss Securities.

“This rally has seen some directional mismatches as well. While instances where FY22 earnings have seen an upgrade (versus January 2020) and valuation multiples have contracted are very few, there are more than 50 stocks where the valuation multiple has expanded over 15% even as FY22 estimates are down 15% compared to a year ago," Edelweiss Securities said.

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Published: 05 Mar 2021, 05:20 AM IST
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