Have patience, midcaps will deliver: 50% see EPS rise above 5-yr average

NEW DELHI: Earnings recovery is the magic word every analyst is looking for this results season. Over 50 per cent of the companies in the S&P BSE Midcap index have registered an increase in earnings per share (EPS) over their five-year average.

Out of the 83 stocks in the S&P BSE Midcap index, as many as 56 saw an increase in EPS multiples compared with their respective five-year averages. The multiples expanded in line with expectations.

Companies that saw an increase in EPS include names like Ashok Leyland, Bajaj Finance, IndiaBulls Housing Finance, Bajaj Finserv, Torrent Power, Emami, Apollo Hospitals and Biocon, among others.
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Midcap stocks saw huge buying interest from retail investors as well as domestic mutual funds in the past one year on hopes of a continuation of more pro-growth policies from the Modi government.

The S&P BSE Midcap index slipped a little over 3 per cent in the last 12 months compared with 16 per cent fall in the S&P BSE Sensex. But some of the midcap stocks have risen up to 70 per cent since January 1, 2015, which include names like Ashok Leyland (up 69.6 per cent), Bajaj Finance (up 65 per cent), 3M India (up 51 per cent), Britannia Industries (up 46 per cent) and Marico (up 31 per cent).

However, not every stock that saw an expansion in EPS gained. As many as 30 stocks are still trading in the negative despite an increase in EPS, which include names like Nalco, Exide Industries, Adani Power, ABB India, Tata Chemicals and L&T Finance.

Excess flows over the past few months propped up valuations of some of the midcap stocks and they started looking expensive, leading to a correction. This is evident from the fact that almost 30 companies are still trading in the negative despite reporting earnings growth.

Stocks that are trading in red include the likes of Nalco (down 38 per cent), Exide Industries (down 37 per cent), Adani Power (down 35 per cent), JSW Energy (down 27 per cent), ABB India (down 25 per cent) and Tata Chemicals (down 20 per cent), among others.

Most analysts remain positive on the midcap space, but at the same time, they advise caution because most of them are already trading with expensive valuations. The expansion of PE multiples in some of the stocks is more than 100 per cent compared with their five-year averages.

Midcap stocks are usually direct proxy to plays on the economy theme. An economic recovery is definitely under way, but an 8 per cent GDP growth may still be a tall order next year. Investors have to be cautious while picking stocks in this space, but there are a number of hidden gems.

“We have been advising investors that while the domestic economy is showing some initial signs of improvement, corporate earnings growth will be much better in FY17-FY18 compared with say FY14-FY15-FY16,” Mahesh Nandurkar, India strategist, CLSA, said in an interview with ET Now.

“In the last three years, average corporate earnings growth has been about 4-5 per cent. In the next two years, that number should be about 15 per cent. Yet the expectations on certain sectors and stocks are still elevated,” he said.

Nandurkar is looking at stocks that can deliver 15 per cdnt plus earnings growth with a high level of confidence. That is where the valuations are not really out of whack.

The honeymoon period that most midcap and smallcap stocks enjoyed back in 2015 was largely supported by strong flows from domestic mutual funds (MFs).

Mutual funds poured in over Rs 70,000 crore into domestic equities during that calendar year, and most of that money went into midcap and smallcap stocks.

Most experts said this number could well jump to Rs 1,00,000 crore in 2016. But if earnings fail to meet expectations, technical adjustments could happen in some of the stocks. But investors should not get too worried about it.

“When one invests in midcaps, there has to be a clear understanding that they carry higher risk,” said Kunj Bansal of Centrum Wealth Management.

"A lot of quality midcaps have not fallen as much as the market. While most of the largecap stocks are available at 20 per cent below their peak levels, midcaps are available at 30-40 per cent discount. This is the time to revisit your portfolio,” he said.