Midcaps hit a home run, several benchmarks being reset: Motilal Oswal

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As small and mid-cap stocks outperform large caps, the NSE Midcap 100 and Small 100 indices have generated continuous positive monthly returns amid the pandemic. According to the India Strategy report by Motilal Oswal Financial Services, “The NSE Midcap 100 index have generated consecutive positive monthly returns of 102% in the last 13 months. While the NSE Smallcap 100 generated consecutive positive monthly returns of 67% over last 8 months.”

Nifty’s underperformance v/s the midcap index on a 12-month rolling basis is at the highest levels since the global financial crisis (GFC). For the Smallcap index, this rolling 12 months underperformance is at the same level as during the GFC. Despite these recent sharp gains, the NSE Midcap 100 and NSE Smallcap 100 indices have underperformed the Nifty since their previous peaks of Dec’17. The Nifty has gained 51% since Dec’17, while the NSE Midcap 100 has advanced 28% and the NSE Smallcap 100 index returned 6%.

M-cap contribution

The recent broad-based rally has led to a sharp increase in m-cap (market capitalization) contribution from the midcap and smallcap universe. The m-cap of the NSE Midcap 100 index now contributes 12.1% to the overall m-cap, up from 9.8% in Mar’20. The m-cap for smallcap companies, as a percentage of overall m-cap, has increased to 3.7% at present from 2.7% in Mar’20. Peak contribution for the NSE Midcap 100 is 17.4% and for NSE Smallcap 100 index is 4% of total m-cap. In terms of absolute m-cap, NSE Midcap 100 stands at Rs 28 lakh crore while that for NSE Smallcap stood at Rs 8.5 lakh crore are at the highest ever levels.

Divergence in valuations

The Nifty Smallcap 100 has been trading at a premium to the Nifty for the first time since Dec’14. It is trading at a premium of 7% v/s an average discount of 21% on a 12-month forward basis. Valuations for the Nifty Midcap 100 index are on par with the Nifty on a 12-month forward basis. However, if one were to remove loss-making companies from both the indices, then the Nifty Midcap & Nifty Smallcap indices are trading at a trailing P/E (price to earnings) of 21x & 23x FY21 earnings, at a marginal discount to the Nifty. Valuations, however, are hiding more than what they are revealing. If one looks at the trailing 12-month valuations for the NSE Midcap 100 and NSE Smallcap 100 indices, there is a wide divergence within the index.

Earnings delivery critical

The sharp outperformance of midcaps, bolstered by healthy earnings, improved sentiments, benign liquidity, and low cost of capital, has more than bridging the valuation gap v/s largecaps. Meanwhile, balance sheets and cash flows have improved in FY21 as corporates tightened costs and deleveraged. Consistent earnings delivery v/s expectations are critical for further outperformance. Any risk-off owing to concerns over potential interest rate hikes may impact midcaps/smallcaps according to Motilal Oswal Financial Services.

Long stretch

The Midcap and Smallcaps have shown strong buoyancy of late bolstered by strong underlying sentiments, healthy earnings performance and low cost of capital. It is noted that the monthly positive returns of these indices vs. Nifty have stretched and had now crossed previous such stretch/near to it. 22% of NSE Midcap 100 components and 23% of smallcap 100 components have more than doubled since Jan’18 peak. However, 37% of Midcap 100 and 43% of Smallcap 100 components are yet to cross Jan’18 peak.