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Small and mid-caps for big gains in 2021

January 16, 2021 10:09 IST

While small-caps have delivered higher returns than their large-cap peers, investors would do well to recognise the incremental risk of investing in these companies.
Ram Prasad Sahu and Yash Upadhyaya report.

Photograph: Kind courtesy Peggy und Marco Lachmann-Anke/Pixabay
 

After two-and-a-half years of muted returns, small and mid-capitalisation companies made a comeback in CY20, outperforming their larger peers.

While the BSE MidCap index enriched investors by 22 per cent, the SmallCap index was up 21 per cent; these were 500-600 basis points higher than the benchmark indices.

The outperformance of the stocks in these categories is expected to continue in the current year, believe brokerages.

Analysts at ICICI Securities expect mid-caps and small-caps to gain more than large-caps and its top picks for the year are in the mid-cap and small-cap space.

The outperformance expectation is based on the hope that the delta in earnings growth during a recovery phase will be high in mid-caps and small-caps vis-a-vis large-caps.

Further, the price-multiple expansion in them will also add to their capital appreciation.

What the Street is betting on is that lower interest rates and cost rationalisation will help these companies deliver on the operational front, as well as reduce or improve their financial leverage position.

Amit Khurana, head of equities at Dolat Capital, expects significant operating leverage to play out on better utilisation, as well as lower interest cost.

He also highlights the fact that despite the sharp rise in the indices (FY21 year-to-date returns for the BSE Midcap and the BSE SmallCap stood at 72 and 90 per cent respectively), valuations are still below the long-period averages.

Given these factors, we have picked stocks -- recommended by brokerages -- which have robust prospects, offer good upside, and are not trading in the expensive zone (barring a couple).

However, while small-caps have delivered higher returns than their large-cap peers, investors would do well to recognise the incremental risk of investing in these companies.

Ajit Mishra, VP (research) at Religare Broking, expects the broader markets to outperform the benchmark indices but advises investors to stick to good quality companies.

"Fundamentally sound companies, operating in niche segments with decent market share and clean promoter background are important criteria while investing in small and mid-cap companies," he says.

Kaveri Seeds

Focus on increasing the share of high margin non-cotton business, strong free cash flow generation, and robust track record of rewarding shareholders through dividends and buybacks are the key tailwinds for the stock.

Engineers India

With a strong order book of Rs 9,000 crore (3.1x trailing 12-month sales), growth visibility continues to be robust.

Strong balance sheet and attractive valuations, according to analysts, are positive, too.

Federal Bank

Lower exposure to stressed sectors, exposure to higher-rated corporates, and better underwriting are likely to keep credit costs low.

Further, a strong liability franchise will help expand the balance sheet without taking too much risk.

Despite the strengths, the stock is trading lower than historic valuations, as well as at a discount to mid and small-tier banks, says Ambit Capital.

NHPC

Regulated business model and capacity addition outlook provide earnings visibility for the largest hydroelectric power generation company in India.

Improving operational performance resulting in higher incentives will provide an extra fillip to earnings, according to analysts at ICICI Securities.

Birla Corporation

A 15.5-million tonne capacity expansion to aid diversification and boost volumes, while the focus on premiumisation and improving product mix will likely help realisations.

Further, cost optimisation efforts are expected to reflect positively on operating profit and the return ratios, according to analysts at Anand Rathi Research.

Feature Presentation: Aslam Hunani/Rediff.com

Ram Prasad Sahu and Yash Upadhyaya
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