Right here waiting
Muthukumar K & Amit Bhandari
It’s typical for mid-caps to outperform during a bull run. But this time the journey to 9000 has not had an impact on the performance of mid-cap stocks. Slower earnings growth of mid-cap companies could be one of the reasons, but it’s too early to write them off.
IT was a blockbuster week. The sensex finally touched the magical 9000 figure, the country reported a robust GDP growth of 8.1% for the half year ended ’06 and, for once, crude did not play the party pooper, stabilising at $56-57/bbl, almost 20% lower than the earlier highs. So, at the macro level, the picture remains bright with interest rates being the only concern going ahead. All this would have trickle-down effects on Indian businesses over the longer term.
So, is everything in place for the stock market?
Well, not really. The rally in recent months has shown an aberration. Mid-cap stocks hardly witnessed a rally in the current bull run. In fact, large-cap stocks managed to outperform the mid-caps by a wider margin in ’05. For the calendar year ’05 till date, while the BSE sensex gave a return of 34%, the CNX Midcap could manage a return of only 28%. This is hardly normal.
Historically, it has been seen that mid-cap indices outperform the large-cap indices in returns. Mid-caps had outperformed in ’04 when the CNX Midcap 200 gave a return of 42%, the sensex notched a mere 13%. Market observers attribute the aberration to two reasons. Mid-cap companies witnessed slower earnings growth in the first half of ’06. So, market analysts turned instead to companies where visible earnings were higher. In HY06, PAT grew by 31.6% for CNX mid-cap companies as compared to the previous year.
This is far lower than the 60% growth in FY05. Sensex stocks (excluding Bharti Tele-Ventures) managed 28.4% earnings growth. Another reason is that perhaps the mid-cap outperformance in ’04 is getting evened out in ’05. The market is probably digesting the earning numbers before taking further positions.
This relative underperformance of mid caps poses an opportunity for investors to look at the segment. Says Tridib Pathak, CIO, Cholamandalam MF, “It is difficult to generalise and say that mid-cap stocks have underperformed the market. But then, without doubt, even at these levels there are mid-sized companies, which are either undervalued or are on a high-growth trajectory”. Says another fund manager, “Mid-cap stocks are not necessarily undervalued, but then it has been seen that these companies grow at a faster pace.”
One way to look at valuations of mid-caps versus large-caps is to look at the P/E ratio of respective indices. Here, there isn’t much difference. The sensex currently quotes at a P/E of around 18 times and so does the BSE Midcap. However, the difference is that there are many more mid caps compared to large caps, since any company with market cap ranging from Rs 200 to Rs 2,000 crore could be clubbed as a mid caps. With a few hundred stocks to choose from, the chances of finding an attractive buy are perhaps more in the mid-cap space now.
ET Big Bucks looked at a whole bunch of ratios for the mid-cap universe. While obviously cheap companies are few now, there are some which look reasonably priced after factoring in the historical ratio. The task before the investor is to see which of these have decent growth potential as well.
Alok Industries, Ruchi Soya and GTL are companies that appear to be sitting on a lot of cash currently. If adjusted for cash holdings, these companies are available at attractive valuations. Other things remaining constant, cash per share should form the rock bottom for a share price. Alok Industries has cash per share worth Rs 32, while its current market price is Rs 74.
If one were to look at the company’s P/E after adjusting for cash in books, it’s cheaper at 6.4 against the unadjusted value of 11.3. GTL is quoting at a price of Rs 110, while its cash per share is Rs 88. So, while its current P/E is 16.4, when adjusted for cash in books, its P/E is at 3.3.
This is assuming that the accounts as certified by the company auditor are correct. Also, it is crucial to discount any stocks that have recently gone for public issues that could bloat its cash holdings.If one were to compare the cash earnings per share along with market price, there are a handful of stocks that are quoting at lower multiples.
Essar Steel, for example, has a cash P/E closer to 1.Other companies with high cash P/E include Videocon International at 1.25 and Bhushan Steel & Strips at around 2 times. Of course, one has to look at its individual business to see whether such lower multiples are justified.
