In recent years, India’s mid-cap and small-cap segments have experienced significant growth, outpacing large-cap stocks to an extraordinary degree. According to UBS, this trend has created a widening valuation gap that is now at historically high levels. The firm highlights that the divergence between the Nifty Midcap 100 and Nifty 50 indices has reached unprecedented levels, a phenomenon driven primarily by aggressive re-rating during fiscal year 2023-24. This sharp contrast in stock performance is raising alarm bells among analysts, suggesting that a correction in the small- and mid-cap (SMID) market may be imminent.
UBS draws a parallel between the current market scenario and the corrections witnessed in the 2018-19 fiscal period. The firm’s analysis indicates that a significant correction in mid-caps and small-caps is long overdue, as roughly 80% of the 20 SMID-heavy sectors tracked by UBS—including chemicals, home improvement, and exchanges—are either trading at or above their three-year average multiples. Such extremes often signal an impending market correction, emphasizing the need for investors to brace themselves for potential downturns.
While the current market conditions pose challenges for top-down value investment strategies, UBS believes that investors willing to adopt a bottom-up approach can still discover potential opportunities. The focus would ideally shift toward companies with robust fundamentals that showcase resilience in the face of broader market volatility. One such opportunity is Delhivery Ltd, projected to capitalize on its express and part truckload segments, with an anticipated target price of 525 rupees—a forecasted increase of 57% from current levels.
Other stocks such as Indian Energy Exchange Ltd (IEX) reflect a similar paradigm. Rated a buy with a target price of 260 rupees, IEX is expected to witness a 49% upside, propelled by a 19% year-over-year rise in trading volumes, particularly in real-time and green markets. Additionally, the Multi Commodity Exchange of India (MCX) is also positioned favorably, with a target price of 8,000 rupees suggesting a 35% upside. Its growth strategy hinges on diversifying product offerings, including weekly options and electricity derivatives.
Despite prevailing fears of sequential growth deceleration, which UBS considers overstated, several companies in the SMID sector display promising indicators. For instance, Ramkrishna Forgings Ltd is anticipated to deliver a striking 66% upside, driven by robust revenue visibility from railway orders. Similarly, Shyam Metalics and Energy Ltd, with a projected 53% return, stands to benefit from its foray into battery-grade aluminum foil and the potential for anti-dumping duties on imports from China.
As we look ahead, the small-cap and mid-cap sectors in India present a double-edged sword: while opportunities abound, the specter of a correction looms large. Investors are advised to execute discernment in their strategies, leveraging a bottom-up approach to identify resilient firms amid market volatility. Given the historical context and emerging indicators, the next phase for mid-caps and small-caps will undoubtedly be pivotal in shaping the investment landscape.