Small and midcap trade at up to 50% premium, says Bajaj Life CIO. Why largecaps look better now

Midcaps and smallcaps may still offer strong earnings growth, but much of that optimism is already reflected in their prices. With the broader-market indexes trading at premiums of as much as 50% to their long-term valuations, Bajaj Life Chief Investment Officer Srinivas Rao Ravuri sees a more compelling risk-reward opportunity in largecaps.

After years of outperformance by the broader market, Ravuri says largecaps now offer better valuation comfort, earnings visibility and room for recovery. Edited excerpts from a chat:

Despite seeing positive FII flows in the previous two months, Nifty hasn’t moved an inch. Is this foreign money finding value beyond Nifty companies in mid and smallcap names?


While FII selling has eased recently making them net buyers when including primary market activity, much of this capital is being absorbed by a strong wave of new equity supply. Between the recent surge in IPOs, Government OFS activity, and pre-IPO private equity exits, fresh inflows are largely funding new issuances rather than driving the secondary market. This absorbs liquidity and limits immediate secondary market momentum, a trend likely to persist with several major IPOs still in the pipeline. Furthermore, while we notice selective foreign interest in mid and small-caps, large-caps are facing a relatively slower earnings growth, making it more challenging to draw incremental flows. Ultimately, managing this substantial supply of new paper remains a key driver of market dynamics right now.

Crude oil has emerged as perhaps the biggest macro risk for India, with Brent recently trading around the mid-$90s. Would you cut exposure to equities if crude stays elevated?

Crude remains an important risk for India because we import a large part of our oil and gas requirements. The sensitivity of the economy and markets has come down over the years, but a sustained rise in crude still has an impact through inflation, the current account, government finances and corporate margins. The extended duration of elevated crude prices over the past six months has exceeded initial expectations. While government and state-owned energy entities are currently absorbing much of the price pressure—limiting the direct pass-through to retail consumers—this buffer has bought the market time. We currently have a positive stance on equities with a preference for large-caps, though any further rally or extended plateau in oil prices at the current higher levels will require a calibrated review of our portfolio positioning.

Global bond yields are rising and the strong US jobs report has brought another Federal Reserve rate hike back into focus. For an Indian institutional investor, does this change the relative attractiveness of equities versus fixed income, and could higher yields put another ceiling on equity valuations?

Higher bond yields are clearly a headwind for equities. They can put pressure on valuation multiples, and, at the corporate level, higher borrowing costs can also affect earnings. So, this is something we are watching closely, particularly because we expect Indian yields to move higher over the next few months. But when we look at the overall risk-reward, we still prefer equities at this stage. We expect earnings growth to recover and see the potential for double-digit equity returns over the next 12–18 months. Large-caps, in particular, are reasonably valued relative to their own history and the earnings recovery is not fully reflected in current valuations, in our view. So yes, higher yields can put a ceiling on valuations, but we don't think they are enough to change our overall preference for equities over fixed income right now.

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Banks have corrected enough for valuations to become substantially less demanding than some of the market’s popular growth sectors. Are financials now one of the best risk-reward opportunities in the market, and would you favour private banks, PSU banks, NBFCs or insurers here?

Financials, and particularly banks, probably offer one of the best combinations of growth, earnings visibility and valuations in the market today. Credit growth continues to strengthen, while the large mobilization under the FCNR(B) scheme has also helped address some of the concerns around deposits. There could be some near-term margin pressure for banks, but we believe stronger credit growth should more than offset this over time. Asset quality remains benign and most banks have comfortable capital positions. Within financials, we have a clear preference for large private banks. We remain quite positive on the private banking space, although we would be mindful of individual banks facing company-specific issues, including management transitions. So, the sector backdrop is quite favourable, but we would still be selective within the space.

IT has also derated significantly, but the sector continues to face uncertainty around US interest rates and discretionary technology spending. Is Indian IT becoming a contrarian opportunity, or do earnings estimates still have further downside?

Indian IT is certainly becoming interesting from a contrarian perspective, but I would look at it more as a tactical opportunity than a structural re-rating story. The sector has come under pressure again after a couple of good months in July and August and remains one of the biggest underperformers this year. There are two issues here. The near-term earnings outlook remains uncertain, partly because of the deflationary impact that AI could have on some technology services. That may become clearer over the next few quarters. The bigger question, in my view, is the terminal value of the sector. Even if near-term earnings recover, it may be difficult for the sector to get back to the valuation multiples it enjoyed earlier. So, we would be tactical on IT—buy when pessimism becomes extreme and reduce exposure as valuations recover. After the recent correction, we think the sector is getting close to another attractive entry point.

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After the correction, would you allocate incremental money to large caps or still look at mid- and smallcaps?

At this point, we have a clear preference for large-caps. The performance divergence has become quite extreme, with the Nifty 50 up only around 5% since the beginning of this financial year, compared to sharp gains of roughly 18% in mid-caps and 31% in small-caps. This comes after two to three years of significant outperformance by the broader market. Some of that has been justified by stronger earnings growth, but multiple expansion has also played a role. The Nifty 50 is now trading close to its long-term average one-year forward P/E, while midcaps and small-caps are trading at roughly 25–50% premiums to their respective long-term averages. We do expect strong earnings growth from the broader market, but we think a lot of that is already reflected in valuations. So, for incremental money today, we find the risk-reward much more attractive in large-caps.

Which sectors in the broader market now offer genuine earnings-backed opportunities, and where do you still see valuation excesses?

We continue to see good earnings-backed opportunities in the defense and power value chains. Companies in these segments are adding new orders on top of already strong order books, so the earnings visibility over the next two to three years remains quite strong. There are also some very powerful structural trends supporting these businesses—the energy transition in India, the build-out of AI infrastructure globally and the increasing indigenization of defense production in India. The one thing we would be careful about is the price being paid for this growth. In several cases, valuations have already become quite demanding and leave limited room for disappointment. On the other side, some consumer-staple companies still look expensive even after the correction, given the relatively modest growth they are delivering. So, we like the earnings visibility in defense and power, but we would not chase valuations. A good business does not automatically make it a good investment at any price.

What are the broad earnings expectations from the Q2 earnings season, and do you think the base effect will become a problem for some of the GST beneficiaries Q3 onwards?

We expect Q2 to broadly continue the positive trend we saw in Q1. The first quarter was better than expectations, with the broader market delivering double-digit earnings growth if you adjust for the losses of the oil marketing companies. So, we remain reasonably positive on the earnings trajectory. On GST beneficiaries, the base effect will obviously start becoming more visible from Q3, particularly for revenue growth. But I don't think that necessarily means earnings growth will slow down. In several segments, the GST cut supported demand, but the benefit did not fully flow through to profits because higher raw-material costs put pressure on margins. We expect some of that margin pressure to reverse from Q3. So, while the revenue growth numbers may look less impressive because of the higher base, earnings growth can remain strong as margins recover. I would look at both revenue and margins rather than focus only on the headline growth numbers.