Investors usually make a beeline for blue-chips when the business environment is uncertain. But the reverse has been true in recent times.
Compared to blue-chips, investors have been willing to pay similar or higher price-earnings multiples for mid- and small-cap stocks. The PE multiples (the price paid for every rupee of earnings) of the small- and mid-cap indices of the BSE are now at a premium to the Sensex, having traded at a discount previously.
In the year to date, while the Sensex delivered a return of nine per cent, the BSE Midcap index was up 16 per cent and the BSE Smallcap index gained 14 per cent. Similarly, the CNX Midcap and Smallcap indices have outperformed the Nifty by a wide margin.
Performing better
In the market correction since February, small- and mid-cap stocks have not fallen much more than the Sensex. In year to date, seven in 10 stocks in the BSE Midcap universe have done better than the Sensex.
For instance, the stocks of United Bank, Honeywell Automation, Bata India and Hathway Cable are up 50 to 60 per cent.
Higher PEs
The BSE Smallcap and BSE Midcap indices trade at PEs of 21.3 times and 17.8 times respectively. That's a premium to the Sensex's 16.6 times. Similarly, the CNX Smallcap index, at a PE of 20 times is well above the Nifty's 17 times.
Now why are investors willing to pay a premium for mid-sized or smaller companies?
One explanation could lie in their ability to deliver superior growth. Mid-cap companies managed a better sales growth than the large caps for the March 2012 quarter. Revenues for the companies that make up the BSE Midcap index (excluding banks and financial institutions) grew 21 per cent for the March 2012 quarter.
In contrast, the Sensex companies posted a collective year-on-year growth of 19 per cent in the March 2012 quarter.
But on the profits front, large-cap companies have actually expanded net (adjusted) profits by 13 per cent. This is not the case with mid-cap companies, whose collective net profits declined 23 per cent. The small-cap universe stocks put up a worse show with their net profits shrinking by half.
Despite the set-back on net profits, market participants appear to have taken to mid-cap stocks because they generally tend to outperform during periods of falling interest rates. With the interest rate cycle reversing direction this year, investors may have begun to bet on interest cost savings and better profitability for smaller companies.
According to Mr Ravi Shenoy, AVP, Product Development at Motlilal Oswal Securities, mid-cap and small-cap stocks could have been spared as they are likely to see a far larger improvement in profitability than the large-cap companies if the interest rate cycle turns down.
Mr Chokkalingam, Group CIO, Centrum Wealth Management, points to the uninspiring big picture. As he puts it, the successful emergence of several micro stories such as TTK Prestige and City has helped bring mid-cap stocks into the limelight.
Further, large-caps are hardly immune with several falling off the cliff post the downturn of 2008-09.