Satish Menon: Small-cap Stocks Outperforming Mid- and Large-caps in our Outlook

“Our outlook favours small-cap stocks over mid- and large-caps. This is because the comparative valuation is compelling and small caps are trading near the long-term averages, while mid & large are substantially above the average,” says Satish Menon, Executive Director at Geojit Financial Services.

In an interview with ETMarkets, Menon said: “Small companies generally benefit from a lag effect, hence, demand and operating margin are forecasted to benefit in the next 1 to 2 quarters” Edited excerpts:

We have seen a dream run on D-St with Sensex hitting 67000 and Nifty50 heading towards the 20,000 mark. Is this too good to be true and we are running ahead of fundamentals?

We find no evidence of over-optimism in the domestic stock market. YTD, India is underperforming developed markets like the US by 50% (S&P500 18% vs. Nifty50 is 9%), despite the fact that the domestic economy is stable while the US is still at risk of recession.

Our valuation is marginally above the long-term average, which is in line with an upgrade in earnings trajectory of 18% in FY24.

However, the upside of our main indices may be limited in the short term as FIIs inflows can slow down due to central banks quantitative tightening and hawkish monetary policy.

Small & midcap spaces have also been doing well. China plus factor as well as the fall in raw material price supported the sentiment. How should one play this theme?

Currently, our outlook favours small-cap stocks over mid- and large-caps. This is because the comparative valuation is compelling and small caps are trading near the long-term averages, while mid & large are substantially above the average.

And small companies generally benefit from a lag effect, hence, demand and operating margin are forecasted to benefit in the next 1 to 2 quarters.


Sector(s) which you think could get re-rated and why?

Pharma, in anticipation of an improvement in demand from developed economies, reduction in the US pricing issue and improvement in operating margins due to a fall in chemical prices.

Infrastructure, due to an increase in demand prior to the next national election and a healthy balance sheet, is expected to uprate the valuation in the short to medium term.

Banks are trading marginally above the long-term average, justifying room for a better upgrade in valuation as credit growth is stable.

Similarly, the energy sector is poised for an upgrade, benefiting from improved operating margins and cost reductions in key inputs such as crude oil and natural gas.

What is going on with the IT sector? Large cap vs midcap IT which space offers more room on the upside?

IT Q1 results’ expectations are muted, and initial announcements are falling short of forecasts. In the short to medium-term, revenue is being impacted by reductions and delays in IT expenditure in the US and Europe.

However, Indian IT companies are effectively managing the situation by maintaining margins, and a rebound in demand is anticipated in the coming quarters due to stable order book and wins.

The US is anticipated to move out of recession in 2024, and the key future business drivers are cloud computing, digitisation, generative AI, and cybersecurity.

Presently, we have a long-term contra bet on the sector, given that valuations have significantly dropped by 38% from their peak and are currently trading at the long-term average.

The valuation of large-cap stocks is at a discount compared to mid-cap, offering relative attractiveness.

The home building space has attracted some attention recently with companies like Polycab and Havells in focus. What are your views?

The government’s capital expenditure has witnessed a remarkable increase of 29% CAGR, from Rs. 6 trillion in FY21 to Rs. 10 trillion in FY24 (budget).

Stable GDP growth and rapid urbanization have increased the demand for residential and commercial real estate. This has significantly driven demand for pre and post home building items, such as consumer goods.

We have a positive view on both stocks. Havells’ premium valuation stems from its strong brand position in both electrical and consumer durables. The strategic Lloyd acquisition makes it the third-largest player in air conditioners.

RoE is above 20% and has a strong balance sheet (no debt). Polycab, a leading wires and cables manufacturer, achieved better than industry CAGR growth of 14% in revenue and 27% in earnings in the last 5yrs. It has the best operating margins among its peers.

Markets are at record highs and we see some consolidation – things that investors should avoid doing and keep in mind.

Not to get overboard and have a balanced portfolio of equity, debt, gold, and cash. A medium risk-averse person can hold 60% of their equity, while a risk-taker may hold not more than 75%.

Avoid highly valued stocks & sectors while investing should be only on value buying & credentials.


What is your call on global equities vis-à-vis India?

The global market has performed better than the Indian market YTD, which is contrary as the world economy is slowing while the domestic economy is resilient.

MSCI World index is up by 16% YTD compared to 6% of MSCI India. This was due to the extremely cheap valuation of world equity in Q3CY22 as the market underwent a heavy correction during 2022.

However, it is unlikely that this outperformance will persist, as world economic headwinds refuse to go away, and the quantitative tightening measures of central banks will have an effect on the equity market in the upcoming quarters.

However, dollar funds are moving to EMs as a better source of investment, of which India is likely to be a key beneficiary, supporting outperformance during the year.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)

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