How to stand out in current market scenario
1 view
Skip to first unread message
indexed
Nov 28, 2010, 8:15:43 AM11/28/10
to Stakeholders Rights
The bigger the better
Sensex companies offer investors a bigger margin of safety because
they held on to profit margins much better than their mid-sized
rivals.
Mid-cap companies have been late to catch up with their earlier growth
rates which was initially triggered by a fall in input costs,
corporate profits have since then been helped by a pick-up in demand,
coupled with greater pricing power.
The analysis also reveals the sensitivity of profit growth to input
and interest costs. A rise in these two parameters in future could yet
play spoilsport on earnings.
Sequential growth could be used as it is a better yardstick to
highlight the points of deterioration and pick-up in performance.
Mid-caps have so far had a great run in the rally from the March 2009
lows. While the CNX Nifty only doubled in value, the CNX Midcap
delivered a much stronger 170 per cent return in the same period.
ARE the mid-cap stocks are overheated? Well, not really.
Though the initial leg of the 2009 rally saw mid-cap stocks take the
lead over their large-cap peers, these stocks haven't enjoyed as much
of an expansion in PE multiples as their large-cap counterparts.
While CNX Nifty saw its PE multiple expand from 12 times to 21 times
between March 2009 and end-May, that of CNX Midcap rose just from 8
to16 times. The valuation gap makes a reasonable case for investing in
mid-cap stocks.
Though it has narrowed since, what with the PE multiple of the Midcap
index edging up to over 18 times now, the gap still is nowhere near
the earlier instances of ‘overbought' levels. For one, unlike market
rallies in the past when the valuation gap between mid-cap and large-
cap stocks had narrowed down considerably, the gap this time around
does seem to leave reasonable room for appreciation.
For instance, between October 2007 and January 2008 (before markets
crashed), while the PE multiple of CNX Nifty had moved up from over 26
to 28 times, that of CNX Midcap had expanded more from 20 times to
over 26, narrowing down the valuation gap between the two indices
considerably and in no time. Little surprise that it was soon followed
by a crash in equities. Even in May 2006, just before the market
suffered a significant fall, the valuation gap between the indices had
thinned down noticeably. The mid-cap index valuations had even briefly
surpassed that of Nifty-50 then.
Even if we look at the five-year historical average, mid-caps do not
seem to be overheated. The five-year average gap between Nifty and CNX
Midcap has been at about 8-10 per cent and the current valuation gap
is perched in the 14-18 per cent ‘safe-zone'.
What about earnings?
Mid-cap stocks have reported improved financial performance, though it
largely was only in keeping with the improved business environment and
liquidity conditions. In the just-ended March 2010 quarter, the list
of companies comprising the CNX Midcap index reported a 6.7 per cent
growth in sales over the corresponding quarter last year.
Profits however dipped by over 20 per cent, driven down by a drop in
operating margins and interest cover (earnings numbers exclude that of
banks, financial institutions, and refineries and are standalone).
Does that mean mid-caps still have a long road to recovery? While to
some extent it does mean that, much of the current mid-cap valuations
are primed for potential future growth. This may also explain why the
CNX Midcap Index is offering higher earnings growth for FY11 and FY12
(based on consensus forecasts) compared to the narrow indices.
That the companies have grown their sales on a sequential basis too
suggests that the revival in demand is perhaps beginning to trickle
down to mid-cap companies too. On a sequential basis, these companies
reported a 3.3 per cent growth in sales. However for the growth to
reflect below the line, access to liquidity would be crucial, as mid-
cap companies still haven't seen any marked improvement in interest
cover (at six times in the March 2010 quarter, against 6.3 times a
year ago).
Improving cash-flows as demand perks up and an easing capital-raising
environment for mid-cap companies, therefore, may hold the key to
earnings growth. While an increasing interest rate scenario could
spell more challenges for mid-cap companies, pegging up their cost of
capital, it still may not be as difficult to raise funds as it was
during the credit crunch of 2008. Besides, with demand drivers slowly
falling into place, the cost of credit may not bear that high an
influence on business fundamentals, at least as long as the overall
economy continues to grow.
But which sectors have enjoyed a higher re-rating and which lower in
the rally so far? Companies from engineering, infrastructure, capital
goods and shipping have enjoyed a significant re-rating over the year.
Hotel stocks and select pharmaceutical companies too have seen their
PEs gallop over the year.
The re-rating seems to have also been earnings driven, to certain
extent, what with the divergent earnings performance. While companies
in sectors such as chemicals, consumer goods and sugar did not quite
impress with their performance, those in pharmaceuticals, engineering,
infrastructure, and real estate scored high.
How to go about it?
While mid-caps as a category do hold significant investment potential,
how much of it can be extracted depends a lot on sector and stock
choices as well as the tenure of investment. Additionally, look out
for companies with healthy operational cash flows and moderate
leverage as they are better placed to ride a rising interest rate
regime.
While lack of credible investment information on some stocks in the
mid-cap space can be a big hindrance, you can take cues from the
investment moves made by institutional investors.
However, remember, such stocks also are more prone to falls during
periods of market correction. Interestingly, the FIIs have already
increased focus on mid-caps; their stake as a percentage of the total
equity base of CNX Midcap index stocks now stands higher at 15.4 per
cent (March 2010 quarter) from 11.6 per cent seen in the year ago
quarter.
It was at about 14.7 per cent in December 2009. Domestic institutional
investors, comprising mutual funds and insurance companies, on the
other hand, have slightly decreased their mid-cap exposure to 10.1 per
cent from the 10.5 per cent level of a year ago.
Book profits regularly
Investing in mid-caps can become a bit too bumpy a ride for many
investors, as their stock prices tend to be more volatile than their
large-cap peers.
Also, as the impact cost of transacting in mid-caps is higher (than
that of large-caps) these stocks are more prone to downside risks
during market corrections. Investors may, therefore, do well to take
profits regularly.
A good indicator can be the valuation gap between the Midcap index and
the Nifty. Thinning of the gap below the average should perhaps be
reason enough to sweep some profits off the table.
Sensex companies offer investors a bigger margin of safety because
they held on to profit margins much better than their mid-sized
rivals.
Mid-cap companies have been late to catch up with their earlier growth
rates which was initially triggered by a fall in input costs,
corporate profits have since then been helped by a pick-up in demand,
coupled with greater pricing power.
The analysis also reveals the sensitivity of profit growth to input
and interest costs. A rise in these two parameters in future could yet
play spoilsport on earnings.
Sequential growth could be used as it is a better yardstick to
highlight the points of deterioration and pick-up in performance.
Mid-caps have so far had a great run in the rally from the March 2009
lows. While the CNX Nifty only doubled in value, the CNX Midcap
delivered a much stronger 170 per cent return in the same period.
ARE the mid-cap stocks are overheated? Well, not really.
Though the initial leg of the 2009 rally saw mid-cap stocks take the
lead over their large-cap peers, these stocks haven't enjoyed as much
of an expansion in PE multiples as their large-cap counterparts.
While CNX Nifty saw its PE multiple expand from 12 times to 21 times
between March 2009 and end-May, that of CNX Midcap rose just from 8
to16 times. The valuation gap makes a reasonable case for investing in
mid-cap stocks.
Though it has narrowed since, what with the PE multiple of the Midcap
index edging up to over 18 times now, the gap still is nowhere near
the earlier instances of ‘overbought' levels. For one, unlike market
rallies in the past when the valuation gap between mid-cap and large-
cap stocks had narrowed down considerably, the gap this time around
does seem to leave reasonable room for appreciation.
For instance, between October 2007 and January 2008 (before markets
crashed), while the PE multiple of CNX Nifty had moved up from over 26
to 28 times, that of CNX Midcap had expanded more from 20 times to
over 26, narrowing down the valuation gap between the two indices
considerably and in no time. Little surprise that it was soon followed
by a crash in equities. Even in May 2006, just before the market
suffered a significant fall, the valuation gap between the indices had
thinned down noticeably. The mid-cap index valuations had even briefly
surpassed that of Nifty-50 then.
Even if we look at the five-year historical average, mid-caps do not
seem to be overheated. The five-year average gap between Nifty and CNX
Midcap has been at about 8-10 per cent and the current valuation gap
is perched in the 14-18 per cent ‘safe-zone'.
What about earnings?
Mid-cap stocks have reported improved financial performance, though it
largely was only in keeping with the improved business environment and
liquidity conditions. In the just-ended March 2010 quarter, the list
of companies comprising the CNX Midcap index reported a 6.7 per cent
growth in sales over the corresponding quarter last year.
Profits however dipped by over 20 per cent, driven down by a drop in
operating margins and interest cover (earnings numbers exclude that of
banks, financial institutions, and refineries and are standalone).
Does that mean mid-caps still have a long road to recovery? While to
some extent it does mean that, much of the current mid-cap valuations
are primed for potential future growth. This may also explain why the
CNX Midcap Index is offering higher earnings growth for FY11 and FY12
(based on consensus forecasts) compared to the narrow indices.
That the companies have grown their sales on a sequential basis too
suggests that the revival in demand is perhaps beginning to trickle
down to mid-cap companies too. On a sequential basis, these companies
reported a 3.3 per cent growth in sales. However for the growth to
reflect below the line, access to liquidity would be crucial, as mid-
cap companies still haven't seen any marked improvement in interest
cover (at six times in the March 2010 quarter, against 6.3 times a
year ago).
Improving cash-flows as demand perks up and an easing capital-raising
environment for mid-cap companies, therefore, may hold the key to
earnings growth. While an increasing interest rate scenario could
spell more challenges for mid-cap companies, pegging up their cost of
capital, it still may not be as difficult to raise funds as it was
during the credit crunch of 2008. Besides, with demand drivers slowly
falling into place, the cost of credit may not bear that high an
influence on business fundamentals, at least as long as the overall
economy continues to grow.
But which sectors have enjoyed a higher re-rating and which lower in
the rally so far? Companies from engineering, infrastructure, capital
goods and shipping have enjoyed a significant re-rating over the year.
Hotel stocks and select pharmaceutical companies too have seen their
PEs gallop over the year.
The re-rating seems to have also been earnings driven, to certain
extent, what with the divergent earnings performance. While companies
in sectors such as chemicals, consumer goods and sugar did not quite
impress with their performance, those in pharmaceuticals, engineering,
infrastructure, and real estate scored high.
How to go about it?
While mid-caps as a category do hold significant investment potential,
how much of it can be extracted depends a lot on sector and stock
choices as well as the tenure of investment. Additionally, look out
for companies with healthy operational cash flows and moderate
leverage as they are better placed to ride a rising interest rate
regime.
While lack of credible investment information on some stocks in the
mid-cap space can be a big hindrance, you can take cues from the
investment moves made by institutional investors.
However, remember, such stocks also are more prone to falls during
periods of market correction. Interestingly, the FIIs have already
increased focus on mid-caps; their stake as a percentage of the total
equity base of CNX Midcap index stocks now stands higher at 15.4 per
cent (March 2010 quarter) from 11.6 per cent seen in the year ago
quarter.
It was at about 14.7 per cent in December 2009. Domestic institutional
investors, comprising mutual funds and insurance companies, on the
other hand, have slightly decreased their mid-cap exposure to 10.1 per
cent from the 10.5 per cent level of a year ago.
Book profits regularly
Investing in mid-caps can become a bit too bumpy a ride for many
investors, as their stock prices tend to be more volatile than their
large-cap peers.
Also, as the impact cost of transacting in mid-caps is higher (than
that of large-caps) these stocks are more prone to downside risks
during market corrections. Investors may, therefore, do well to take
profits regularly.
A good indicator can be the valuation gap between the Midcap index and
the Nifty. Thinning of the gap below the average should perhaps be
reason enough to sweep some profits off the table.
Reply all
Reply to author
Forward
0 new messages