Lightweights rise with risk appetite

MUMBAI: The adage that good things come in small packages may not have held true for a while if one were to look at the composition of stocks that moved the Indian equity markets.

The rally since June principally revolved around the large-caps, and, to a lesser extent, around mid-caps, with the small-cap segment literally going into a cocoon.

However, over the past month-and-a-half, small-caps seem to have found a firm footing, having outperformed stocks in the mid- and large-cap segments.

Analysts attribute this to people’s risk appetite having improved because of the perceived stability in the market, and thus willing to give higher valuations for such stocks. For the record, Wednesday saw the BSE Mid-cap index managing to beat its May high for the first time since. Meanwhile, the BSE Small-cap index is still 214 points (or 2.7%) short of its May peak.

“Subsequent to the correction witnessed in May 2006, the interest in market rally initially was limited to only the large caps. Fundamentally, the mid-caps looked very attractive, though the market did not participate in that trend,” said Sameer Koticha, executive director of ASK Raymond James.

Large-caps led the rally since mid-June, the mid-caps started catching up by August. And by November, they were on a par.

While the BSE Sensex gained 53.38% between June 14, 2006 (when the index made a low of 8799 points) and November 30, 2006, the BSE Midcap index had returned 53.76%. Over this period, the small-caps had gained less — 47.63%.

Koticha believes the trend will be more broad-based going forward, more skewed towards the mid and small-cap companies.

“The prices of stocks have begun reflecting their earnings growth and hence the attractive valuations,” he said.

But the question, is will foreign institutional investors, who have been in the drivers’ seat as far as large-cap stocks go, be interested in small fry in their main course menu?
No clear answer seems to emerge, though everyone’s clear that they’ll buy where they find value.

“We believe the best strategy for investing in India is to buy on dips and to look for laggards or reasonably valued segments of the market. For example, much of the rally since May has been driven by large-cap stocks: 44 of the 68 stocks in MSCI India have underperformed the index over this period. Mid-caps are currently trading at a big discount to large caps (their 12-month forward PE is only 14.5 x) and we believe this is a space to focus on,” said Garry Evans, Pan-Asian Equity Strategist at HSBC.

Deepak Jasani, head of retail research at HDFC Securities offers another insight. “There is a set of FIIs who are not bound by market cap hindrances and who have a hedge-fund kind of mentality to assume higher risk. With companies in the private equity/venture space becoming more expensive, some of them are willing to look at the secondary market to earn higher returns even when they do not have a say in the running of the company,” he says.

The mismatch between price and earnings of mid- and small-cap companies have also seen many domestic mutual funds launch products whose investment theme is based around these stocks of smaller capitalisations. They include the DSP Merrill Lynch Small and Midcap Fund, Reliance Long Term Equity Fund, Sundaram Select Smallcap Fund and the JM Small and Mid-cap Fund. As they raise and deploy their moneys, these stocks are destined for some action.

“Early spotters make a lot of money and everybody has his own list of small- and mid-cap stocks, which are likely to go into the next orbit,” says Jasani of HDFC Securities.
At the same time, analysts said, investors should be aware that these stocks are susceptible to very sharp falls in case of market downturns. — With inputs from Venkatesan Vembu in Hong Kong