Small, mid-cap stocks to lead as earnings growth democratizes in India
New Delhi. Small and midcaps have been the drivers of post-Covid recovery in the stock market. Some of the upside may subside in the coming quarters, but the medium-term outlook remains strong.
There has been democratization of earnings growth with wider participation of companies in India, which is being reflected in SMIDs enjoying their time in the sun. Fragmented industrial sectors, with no clear leader, reinforce the momentum, Emkay Global Financial Services said in a note.
“We see broader markets heading into the remaining months of FY2014 with a negative bias,” the report said. “The long-term top-down narrative remains attractive, with small and mid-caps leading the market for the next 2-3 years.”
The report pointed to three key themes on the stock:
Manufacturing: A multi-year development trend that has not yet been fully realized. This includes capital goods, auto ancillaries, chemicals, metals and pharmaceuticals. The focus of this theme will be on SMIDs, as there are few large caps available.
Premiumisation: B2C companies will generally lag behind, but we see opportunity in premiumisation. As India’s per capita income breaks new highs, the growth of the premium segment should gain momentum and companies catering to this segment should outperform.
Technology wave, which has allowed mass market companies (primarily consumer and BFSI) to have a non-linear footprint expansion. The report said that Internet companies and digital transformers benefit and are in third place among the better performers.
Tata Mutual Fund said in a report that the drivers of growth in Indian stocks were cut down on financials (ROE normalization), capital goods and urban consumption.
It said healthy cash flows in the corporate sector and improvement in the investment cycle due to the government’s counter-cyclical fiscal policy make us bullish on the industrial/capital goods sector, making us bullish on the sector.
Recovery in power demand, capex in generation (renewable + thermal) and transmission suggests an overweight stance on sectors/stocks.
In the financial sector, growth will normalize after a period of margin expansion and lower credit costs.
Re-ratings of mid/small caps have been significant in the last 6-12 months, with more bottom-up likely to happen in the future depending on execution. Large cap banks are still fairly valued.
The report said the risk of a decline in corporate earnings has reduced. Banks and capital goods lead a positive earnings upgrading cycle.
Urban consumption is slowing due to the impact of inflation and interest rates after a significant increase in 2022. In contrast, rural consumption is increasing, albeit slowly. The downside in pharma seems limited as US pricing normalizes.
Topline risk sectors (e.g. IT, FMCG) have stabilised; Margins will be supported by lower input costs or lower attrition and wage pressure.
The biggest risk to the market comes from the behavior of crude oil prices if the conflict in the Middle East worsens. The report said that this could reduce India’s valuation premium.
For the year ending September 23, PSU banks (+76%) and realty (+36%) made the most gains, while energy (7%) was the lowest performer. The report said that large caps made marginal gains in the month of September 2023. However, mid and small caps continue to deliver alpha.
Strong momentum in the small cap segment supported by expanding economic growth and large domestic inflows into dedicated funds.
FIIs were net sellers for FY23 with outflows at around US$10 billion, while DII inflows were strong at US$33 billion. FII inflows increase to US$17.4 billion and DII inflows increase to US$5.5 billion for FY24TD.
According to Bandhan MF’s Equity Market Outlook, preference is given to domestic stocks over global ones – however, this needs to be adjusted with valuation/election risk.
Globally, energy transition is a topic that could create some healthy alternatives in utilities, capital goods, cables, etc.
Rural/low-end consumption sectors look attractive due to election spending prospects and reduced COVID/inflation-related balance sheet shocks, the report said.
The report said that as nominal growth slows, elite small caps could deliver healthy returns.
VK, chief investment strategist, Geojit Financial Services. “Ideal buys in declining sectors are capital goods, automobile and financial sectors. Capital goods and automobile are in a cyclical uptrend and this cycle will last for a few years,” Vijayakumar said.
“There is strong demand for capital goods and the automobile sector will benefit from demand recovery and margin improvement from fall in commodity prices. Financials, especially banking, are performing well and valuations are below historical averages,” he said. “
IANS
