midcap stocks: Midcaps likely to rise further on P/E comfort

ET Intelligence Group: The record high valuation premium of large-cap stocks compared with midcaps is likely to renew investors’ interest in the latter.

Midcaps have underperformed by 26 per cent as compared to their large-cap counterparts in the past three years following investors’ flight to high-quality largecaps amid rising uncertainty in the market.

This created concentrated positions in the large-cap segment. For instance, of the 1,200 points that the Nifty 50 index gained from its lows in September, 64 per cent was contributed by just four stocks — Reliance Industries (25 per cent contribution), HDFC Bank (15 per cent), ICICI Bank (14 per cent) and HDFC (11 per cent).

Besides, the weight of the top 10 stocks in the Nifty reached a record level of 60.6 per cent, according to CLSA.

Despite their underperformance, investors have not outrightly lowered their exposure to midcaps. Domestic mutual funds received inflows of Rs 14,650 crore in the midcap and small-cap funds in the past 10 months, which is about 30 per cent of the total fund flow, according to AMFI data.

The price-earnings (P/E) premium of the MSCI India index over the MSCI Midcap index reached a five-year high of 56.3 per cent, according to Bloomberg data. The price ratio of the mid-cap stocks to the largecap stocks has dropped to the lowest level since 2012.

The favourable risk-reward of midcap stocks may prompt investors to turn selectively positive in the near term. Midcap stocks have outperformed in the past one month. Their performance may improve further if the economic downturn shows signs of bottoming out.