Investment Opportunities in Mid & Small Caps during Covid-19

4 min read
Investment Opportunities in Mid & Small Caps during Covid-19

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Investors are surprised at the pace of recovery of the market from the March, and markets have rallied a lot faster than what anyone would have thought.

The Global central banks have injected $12 trillion into the financial system in just five months, and we haven't seen stimuli of this scale in our lifetime and don't expect this will happen again in our lifetime.

Sensex formed a 'Golden Crossover' on its daily chart, which is considered a bullish sign. Whenever it happened in the past, market have surged at least 15-20% (see below chart).

A 'Golden Crossover' occurs when the short-term 50-day moving average curve crosses above the long-term 200-day moving average curve.

Nifty50 and Nifty Midcap had formed a similar 'Golden Cross' in the market and Nifty Smallcap is also moving towards the bullish confluence. Nifty Smallcap is up 68% from the March lows while Nifty Midcap has surged 52% in the same period. The party has not ended yet; I have a reason for that:

Big investors are slowly decreasing their holdings in LargeCaps and moving towards Mid and SmallCaps. More than 40 lakh new investors have opened their demat accounts and most of them are operating in the market.

India is the only emerging market that has received positive flows compared to all other emerging markets that have received negative flows. So undoubtedly higher liquidity and better performance in S&P 500 will result in some rub-off effect on India.

But simultaneously we need to keep a watch on our medical situation. For us, global factors are supportive but local factors also need to be kept in mind.

The market is the lead indicator, whereas the economy is a lag indicator. The market is looking at the future. Economic numbers are mostly capturing the past. The fatality rate has dropped, which probably gives confidence to the market that regular economic activity will resume despite rising cases. US Fed will commit to its interest rates at zero levels for five years.

The continued momentum in mid-caps can surprise us if the market holds up well. There is likely to be one more stimulus that will come right once we get a vaccine.

How to select Better Mid or Small Cap stock

Now while markets are clearly moving up and the market move is slowly getting broad-based as is visible in terms of numbers, one has to keep in mind that certain fundamental factors must be maintained while picking stocks. Therefore we still continue to avoid companies which have significantly high leverage (more debt) and companies which have high fixed cost operating structures.

One unique feature of the crisis this time is whenever you had a crisis in the past, our currency and our forex reserves always ran into a 'worry zone' but this time, surprisingly the currency has been stable. Our forex reserves are now over half a trillion dollars. So, these macro data points will allow us to sleep very peacefully.

Here are two quick ways to spot better ‘buying opportunities’

First of all, the company’s balance sheet should be in good shape should not be extremely leveraged. Second, the company should have cut costs dramatically due to coronavirus. At the end of the day, markets will value fundamentals and profitability. There will be many, many stock-specific opportunities to make good money from it. So, even in a flat market, people can make high double-digit returns by having the right stock.

1) By ‘Being aware’ what’s happening around:

A) A few days back, there was a news that India might impose 10% safeguard duty on Single Mode Optical fibre imports. This may trigger wires and cables stocks like Finolex Cables, KEI Industries, Polycab. (See last one week chart, they all have surged.) Jefferies already given  Buy rating on Finolex Cables with  Price target of Rs 415.

B) After India's import embargo on 101 defense items, defense stocks surged more than 60–70% (See detailed info in this article)

C) Due to the 'Boycott China' campaign, there are two particular sectors -- chemicals and contract manufacturing where there could be the stupendous opportunity, just like the IT sector in 2000.

2) Stocks where big brokerages are betting on:

Everyday Big brokerage houses like Nomura, Citi, Kotak Securities, Macquarie, Morgan Stanley, Credit Suisse, Investec, UBS, BofAML, etc. comes with research stocks.

You need to remember two things. First, they never select stocks with weak fundamentals; second these reports highly impact the market and cause a sharp move in stocks. (Get it everyday here )

Some of the recently researched stocks were as follows:

Some of their recent Mid and smallcaps Picks:

1) CLSA On Phoenix Mills Buy rating maintained Price target raised to Rs 790 from Rs 742.
2) Emkay On Jindal Stainless Downgrade to hold from buy Price target raised to Rs 52 from Rs 52.
3) Morgan Stanley On Lupin Overweight rating maintained Price target of Rs 1,016.
4) CLSA On Dabur Buy rating maintained Price target of Rs 590.
5) CLSA On NTPC Buy rating maintained Price target of Rs 140.

So in short, yes, small caps and midcaps do have good buying opportunity, but we need look for cleaner promoters, healthy balance sheet.

Therefore the valuation multiples will possibly sustain, and that is one set of stocks. The other set of stocks are those who are really beaten down in nature, stocks where valuations have become extremely attractive. Here while it will still take some time for the fundamentals to catch up, there is hope that with improvement and with economic growth starting to pick up. Some of these stocks which are trading at valuations which are significantly below their last 10-year average, will also start seeing a turnaround.


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Akshay Seth
Research Analyst (SEBI Regd.)
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