Are mid-cap and small cap stocks overvalued right now?

Economic Slowdown

Economic figures for India clearly are pointing to a slowdown. In such a scenario how does it impact the stock market? At an aggregate level, it is common knowledge that large caps handle battering far better than mid-caps and small caps.

Page 17 of Times of India, 6 August 2012, Monday, has an article that gives data that proves the same.

ResultLarge-capMid-capSmall-cap
Revenue growth in % (YoY)20.413.310.3
EBITDA growth in % (YoY)8.12.6-6.4
PAT growth in & (YoY)14.5-5.6-57.5

 Source: Times of India

 

P/E multiples for BSE30, BSE Mid-cap and BSE Small cap indices

P/E multiple for BSE30, BSE Mid-cap and BSE Small cap index

 

We see an interesting pattern not seen in the recent years. The small cap index is on steroids and has overtaken the BSE30 and BSE Mid-cap indices respectively in the last few months. As on 1 Aug 2012, the BSE Small cap index had a trailing P/E of 20.6, BSE Mid-cap index had a trailing P/E of 19.2 and the Sensex is at a comparatively sedate P/E of 16.6

Financial data is not good right now for small cap companies as a whole. Prices eventually follow earnings. Its clear that there’s something quite funny brewing in small caps. Mid-caps are bucking the earning trend too.

I think it calls for treading cautiously in mid-caps and small caps right now. The usual applies. I am not saying you cannot find gems in mid-caps and small caps. But there’s froth for sure.

What is your view on this divergence between prices and earnings? Do share your thoughts in the comment box below.

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Please read the disclaimer and make wise investing decisions.

Data:

Times of India has classified companies on the basis of market capitalization as following:

Large: > Rs. 20,000 cr

Mid-cap: Rs. 2,500 cr < 20,000 cr

Small cap: < Rs. 2,500 cr

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Comments

  1. Sandeep Muthangi says

    Kunal,
    Atleast in IT, small-caps have significantly outperformed large-caps this year. However, this isn’t based on a valuation re-rating – it was entirely on earnings upgrades. Small-caps are still 30%-50% cheaper than the large-caps on simple valuation multiples like P/E.

    I am surprised to see that the small-cap P/E multiples are much above the large-cap P/E multiples. Also, there is a sudden and massive increase in P/E at the start of the year – probably some issue related to the rollover. Also, these are based on trailing P/E multiples – not a good measure in these volatile times. Look at some of the smaller cement stocks for instance. There are companies that are doubling their earnings in FY13 but have hardly grown in FY12.

    happy blogging…

    • kunal-pawaskar says

      What you write about the IT sector is true. Mindtree, Hexaware etc. have done well in the last few quarters.

      For the indices actually we cannot get forward multiples. Many of them don’t have analyst coverage. Also, someone has to construct a forward number for the index. For the BSE30, you could do it. For the mid and small cap indices there is a data shortage.

      What you write about the timing at the start of the year when there is an increase is interesting. I will dig deeper. Thanks, Sandeep!

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