dear everyone Comments and views and the opportunities for investment in this category are welcome -------------------------------------------------------------------------------- A shift in the overall investment environment from one of abundant liquidity to that of a severe liquidity crunch may leave mid-cap stocks with lower investor interest for some time to come. -------------------------------------------------------------------------------- Srividhya Sivakumar Not so long ago, a mid-cap bias in your equity portfolio was seen as a sure-fire way to outperform the stock market. This year's long-drawn out correction has, however, changed that. Mid-cap stocks have suffered a greater blow than their large-cap peers in the recent meltdown. But while reams have been written about large-cap stocks and how they fell to institutional selling, what were the trends in returns and holding patterns for mid-caps stocks in the meltdown? Here's an analysis. Since January, the BSE-Midcap index has shed 71 per cent in value against the 56 per cent fall in Sensex. The price to earnings multiple of the index currently hovers around a pitiable 8, way below the 24 that it enjoyed in January 2008. This is in tune with the classic historic pattern followed by mid-caps - outperforming in a rally and lagging badly in a fall. Signal to over-heating But did you know that the valuations of mid-cap stocks could be a signal to where the market is headed? One trend that investors ought to note is that whenever the PE multiple of the mid-cap index has matched, or moved to a premium over the Sensex in the last three years that has signalled the end of a rally. For instance, in April 2006, the PE multiple of the mid-cap index touched 23, slightly ahead of the bellwether's 21. The market corrected steeply the very next month. In early January this year, the mid-cap index was at a PEM of 27, pretty close to the Sensex PEM of 28. The fall this time was so ruthless that the Midcap Index is now at its all-time low. The message from this is: when mid-cap valuations begin to match those of the large-cap stocks it is time to get wary of them, and indeed, of the entire stock market. Mid-cap companies that boasted of a high FII interest have fared as badly in the market meltdown as the ones that did not. FII tag has no impact In the mid-cap basket, stocks with the highest FII interest (shareholding of more than 30 per cent as of September 07) have shed over 70 per cent. Stocks that had less than 10 per cent FII interest have not fared much better - having fallen by 66 per cent. The same trend holds true even if we consider the latest FII shareholdings and map it with the year-to-date returns of stocks. In this case, stocks with more than 30 per cent FII holding saw 71 per cent erosion in value while those with less than 10 per cent fell by 65 per cent. This shows that holding on to mid-caps with low institutional interest may not have helped an investor protect his portfolio any better in this FII-induced market meltdown. Interestingly, the market meted out an equally ruthless treatment to stocks that saw a substantial build-up in FII interest over the past year. Companies such as Monnet Ispat, NDTV, Sintex Industries, ICSA Industries and Peninsula Land that saw a substantial increase in FII holding (of more than 15 percentage points), fell in the 70-88 per cent range. However, companies such as Britannia Industries (minus 25 per cent) and Apollo Hospitals (minus 37 per cent) contained their downside well, despite a reduction in FII interest over the year. Stocks that saw a reduction in FII interest (more than 5 percentage points) too fell by 68 per cent. Daring defensives As with large-caps, stocks that contained the declines well were from the defensive pack. Zandu Pharma (-6.2 per cent), Lupin (-6.3 per cent) and Aventis Pharma ( -28 per cent) in the pharma space and Colgate (-6.3 per cent), Marico (-25 per cent) and Britannia (-25 per cent) appear to have gotten away with little damage when compared to the rest. That said, not all "defensive" stocks got away lightly. Those with an FCCB overhang or forex losses, such as Orchid Chemicals (hostile takeover bid and then forex losses) and Aurobindo Pharma (FCCB issues) fell as sharply as the index. Not surprisingly, mid-cap names in the real estate and construction space were whittled down to a fraction of their original value. Ansal Properties (-94 per cent), Purvankara Projects (-93 per cent), IVR-Prime Urban (-93 per cent) and Parsvnath Developers (-93 per cent) bore the brunt of the meltdown. Capital goods and infrastructure companies apart, some of the media stocks appear to have suffered serious blows, losing more than the mid-cap index. Dish TV, NDTV, Adlabs Films, Balaji Telefilms and Entertainment Network have (till end November) shed more than 80-89 per cent from their January 2008 levels. Relatively high valuations enjoyed by these stocks and the lack of earnings visibility for many of them appear to have contributed to massive selling pressure, as investors turned more risk-averse. what went wrong? The underperformance of the mid-cap pack during a market fall is not a first-time event. The mid-cap index fell more than the Sensex even in October 2005 and in May-July 2006. But this time round, there may be more reason to worry. A sharp shift in the overall investment environment from one of abundant liquidity to that of a severe liquidity crunch may leave mid-cap stocks with lower investor interest for some time to come. To compound the problem, the fall in valuations is backed by very real earnings concerns for mid-sized companies. With the global slowdown clearly beginning to take a toll on Indian companies and credit becoming difficult to obtain, mid-cap companies appear to be at greater risk from slowing order flows or interest rate risks than their frontline peers. Earnings picture In a scenario where even larger companies have suffered a fall in earnings growth, the de-rating suffered by mid-cap stocks can be explained by the significant mark-down in both earnings and future expectations. For the quarter ended September 2008, the BSE mid-cap constituents reported a strong 30.4 per cent growth in revenues. The strong show on the top-line, which was possibly helped by the high inflation environment, however, failed to trickle down to the bottomline, which shrank over 8 per cent. Profit margins took a severe hit, led by higher raw material and borrowing costs and lower contribution from 'other income'. But what may be more worrisome is the increasing interest cost for these companies. On an average, interest cost as percentage of sales increased by a percentage point to 12.6 per cent. That interest coverage also stands at an uncomfortable 1.9 times (from last year's 2.3 times) highlights the increasing difficulties that companies may face in meeting their interest obligations. The threats of waning demand in some export and consumption led sectors, may make topline growth harder to come by in the quarters ahead. So, what next? While it may be too late to throw in the towel on mid-cap stocks, investors whose portfolios sport a mid-cap dominance can consider the following strategies. Switch to large-caps: During intermittent rallies in the market, make a switch from mid-caps to large-caps. Since large-cap stocks have traditionally been the first ones to rise in the market, buying them may help you play the upside better, if not limit the downside. Moreover, large-cap companies may be better placed to weather the economic challenges that India Inc. is staring at. You can, however, maintain the sector weightage in your portfolio by making the switch across companies that are in the same line of business. Hold on to niche players: Companies that do not have a business peer in the large-cap space (for instance, companies such as Everest Kanto, OnMobile Global, AIA Engineering and HEG) can be held, if you are sufficiently bullish on their business models. But try not to average your losses by buying more into some of your losing mid-cap positions. Instead, consider putting fresh money into large-cap stocks. http://www.thehindubusinessline.com/iw/2008/12/07/stories/2008120750700700.htm "Knock, Knock. Who's there? Opportunity. Don't be silly - opportunity doesn't knock twice!" --~--~---------~--~----~------------~-------~--~----~ You received this message because you are subscribed to the Google Groups "Kences1" group. 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