Large-caps or mid-caps? Tackling the slowdown conundrum

Recessionary trends have hit mid-caps hard, but analysts are betting on them for a turnaround in 2020.

Large-caps or mid-caps? Tackling the slowdown conundrum

Companies that boast of a large market capitalisation usually come with certain attributes: healthy bottom lines, an established marketing network, high brand recall, consumer trust, robust sales, and a strong management team – basically, factors needed to survive economic downturns. These companies also offer regular dividends to their shareholders.

Large-cap funds that invest in such companies are considered a safe bet for investment, especially among investors with low-risk appetite and a long-term horizon. Moreover, they are popular among FIIs too. In contrast, small-cap and mid-cap funds typically invest in stocks of companies that have growth potential but lack the financial muscle power or are less established than their large-cap counterparts.

As a result, while these funds fetch high returns for people with a high-risk appetite, returns can be negative when conditions are not so stable – like now. Given these traits, and also the downturn that has slowed down the economy over the past few years, how will you decide which way to go in 2020? Large-caps, or small- and mid-caps… which offer quicker returns?

Related: How large-cap, mid-cap, and small-cap funds are categorised? 

Recent trends

Before taking a call on this, one key aspect to consider is how these have performed in the recent past. (Of course, one’s risk profile and time horizon also matter, but those are personal considerations).

Over the past two years, all three – small-caps, mid-caps, and large-caps – have shown the traits that typify them. As India’s economic growth slowed, the BSE small-cap and mid-cap indices lost 24.7% and 13.7% respectively, while the BSE large cap index gained 10.2%. This, when even the Sensex and the Nifty beat the downturn during this period to posts gains of 19% and 12.2% respectively.

Taking of 2019 specifically, the Sensex gained 14.38% and Nifty 12%, despite national growth slipping to a six-year low of the 4.5% growth seen in the third quarter of 2019-20. However, the BSE mid-cap index slipped by 3% and the small-cap index by nearly 7%. In fact, the past five years have seen mid-caps underperforming by 11%. As for small-caps, the market cap gap between them and large-caps is at a two-decade high. Now everyone seems reluctant to bet on them.

So, what we find is that while the overall economy passed through a slowdown, the key indices managed to rally and the large-caps held their own, while the mid-caps and small-caps took a hit. Yet, experts believe, these very mid-caps and small-caps can yet show an improved performance in 2020, as the sharp fall in valuations in recent times is seen as corrections. 

Kotak Securities, for example, cites data to show that relative valuations of Nifty mid-caps and Nifty small-caps have corrected back to pre-2014 lows. Their advice? Time to buy mid-caps and small-cap stocks.

This advisory came before the annual budget for 2020-21 was passed. Kotak Securities's stance had not changed by March, by when fears over coronavirus gripped the country; it expected mid- and small-caps to make good the underperformance vis-à-vis Nifty-50 Index in the last two years.

Moreover, Kotak Securities said that SIP flows would negate the withdrawal of FII investments and keep the Nifty-50 anywhere between 10,500-11,000.

Related: 5 Large-cap funds that have beaten the benchmark index

Bright spots

Do keep in mind that despite the overall bleak picture that the mid-caps and small-caps present, quite a few of these stocks have been doing exceptionally well. For instance, for every three BSE mid-cap index stocks, two delivered negative returns in 2018 and 2019. In the midst of this mayhem, 12 stocks bucked the trend to soar 20–90% in these two years. 

The trend seems to be continuing this calendar year, with a dozen stocks rallying some 45% till February-end. Here are the highlights:

Honeywell Automation rallied by about 42% over 2018-19, while the performance in the first two months this year was not too bad either – it was up by about 27%.

Divis Laboratories rallied 68% between January 2018 and December 2019, and was up 18% till February-end this year. And now, given that it is in the active pharmaceutical ingredients (API) segment, the corona virus outbreak in China could be a boost for the company and its stock.

AU Small Finance Bank witnessed a rally of 45% over the past two years, fetching returns of some 22%.

Torrent Pharmaceuticals, Muthoot Finance, and Aditya Birla Fashion and Retail have kept pace with the leaders, gaining 17–21% in the first two months this year; their rally in 2018-9 was 30-70%.

Others such as GlaxoSmithKline, L&T Infotech, Godrej Properties, Info Edge, and Berger rallied up to 91% over the past two years, while returns till February-end have been in double digits.

Related: The dos and don’ts with small-caps, mid-caps to get best returns 

Recommended mid-cap stocks 

So, which are the mid-cap stocks that analysts believe could perform well this year? Suggestions have been varied, but here are some pointers:

Value Research Stock Advisor, using the GARP (growth at a reasonable price) strategy popularised by celebrated US investor Peter Lynch, has identified two stocks: Manappuram Finance and Torrent Power. These two have registered an earnings per share (EPS) growth of over 20% in the last quarter of 2019, and in the last five years on an annualised basis, while currently trading at a PE of less than 15.

On the other hand, Kotak Institutional Equities and Antique Stock Broking have, between the two of them, recommended 27 mid-cap stocks. Kotak is smitten by 15, including Bajaj Consumer, CESC, Federal Bank, and Tata Power; while Antique Stock Broking is backing 12, including Chola Investment, Honeywell Automation, and KNR Construction.

Related: 5 best small-cap funds you can bet on 

Last words

One should not only be familiar with the traits that are supposed to typify companies falling in the three groups of market caps, but also be aware that these are only broad suppositions. For instance, for all the talk of large-cap funds beating the downturn and being ideal for investors who prefer quality stocks of established companies, these stocks can still underperform – when compared with small- and mid-caps – even when the market is in an upward movement.

Similarly, despite 2020 being touted as the year of small- and mid-cap companies, these still need certain conditions, such as a low-interest rate regime and a robust economy, to come up with any outstanding performance. It’s true that the economy has begun to move towards that end, but it’s still not there yet. 

So, to begin with, it’s best to look at stocks individually, and not at the category of market capitalisation – large, mid, or small – that they belong to. Ideally, you should be sitting with an authorised financial advisor when making investments. Let's understand the risk associated with mid-cap stocks.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.