The Large Comeback

Inflated Valuations Have Made Mid-caps Prohibitive. And That Segment’s Loss Is the Large-caps’ Gain
 

- Pravin Palande

Mid-cap stocks have been the flavour of the last five years. The NSE’s Nifty Full Mid-cap 100 index went up by 17 percent annually over the last five years against 10.56 percent for the Nifty 50 in the same period; many top mid-cap funds gave returns of as much as 30 percent annually. But are these returns from mid-caps sustainable?

“Three years ago, the mid-cap segment was completely undervalued and there was an 80 percent chance of you picking up a winner. Now that chance has gone down to 20 percent,” says Neelesh Surana, chief investment officer (CIO) of the mutual fund Mirae Asset. “It is now going to be difficult to find undervalued mid-cap companies but that is not to say they are impossible to find.”

In comparison, then, are largecaps—the top 200 companies by market capitalisation— beginning to look attractive? Certainly, from a risk-return perspective, say fund managers.

Large-cap stocks are currently valued at a price-to-earnings (P/E) multiple of 23 times—this is close to their 11-year average of 20. Mid-cap stocks, on the other hand, have a P/E multiple of 30 which appears expensive compared to their 11-year average of 18 (see chart Following the P/E). It then becomes prudent for investors to limit their exposure to mid-caps.

As any fund manager worth her stock will tell you, most mid-caps reach a point from where it becomes difficult to grow. That is typically the time for exits. Then there are mid-caps that operate in the real estate and infrastructure space which end up taking too much debt and are not able to perform after they hit a critical size. One such example is Unitech, a real estate infrastructure company, which was a favourite mid-cap stock in 2007. After the global financial crisis, however, it has lost 90 percent of its value.