Nirmal Bang (Beyond Market) report:
The sudden fall in share prices of mid-cap companies over the past few months has become a cause of worry for most investors, including retail as well as high-net worth individuals (HNIs).
Share prices of mid-cap companies have crashed over 30% to 70% over the last three months and many of them have completely eroded both the market capitalization and the faith of the investors.
More importantly the carnage in mid-caps took many by surprise as no one was able to explain the sudden correction in share prices. The gravity of the event in fact led to a probe by market regulator Securities and Exchange Board of India (SEBI) to check if correction in prices is due to some irregularity or involvement of operators in manipulating the prices.
Less to do with fundamentals
Most market participants believe that the carnage in the mid-cap space has less to do with the fundamentals of the companies.
Apart from this, there is certainly a growing worry that lower economic growth is likely to dent the financial performance of mid-cap companies.
That is because large corporates across different sectors are facing growth issues which will also cast its shadow on the growth of mid-cap companies, especially ancillary companies, which cater to various larger players.
Both investment and consumption has come down and there is less hope of a revival given the impending elections next year and other issues in terms of export demand as well as interest rates.
Besides, poor economic scenario means bad news for companies which are highly leveraged, hitting them in terms of profitability. However, even if one jots down all these points and looks at the cumulative impact, there is still not enough argument to explain such a fall in mid-cap companies, especially in cases where fundamentals of these companies still remains strong.
The Epicentre
The crash in mid-cap stocks punished mostly those investors who kept on averaging the cost of purchase at lower prices in the hope of recovery and valuations turning attractive. But most of these investors have lost heavily and those who went on a buying spree with the leveraged money are now swearing to invest in mid caps as many of them are now trading at historical lows and there is no buyer even at lower prices.
In the absence of retail and institutional buyers in the market, liquidity in mid caps has dried drastically. As many are still sitting on losses, the recovery in share prices is only looked at as an opportunity to exit, thus leading to more supply.
Mid caps came into limelight largely around December last year and January this year as a result of sudden optimism about the Indian equity markets led by policy push and heavy buying by foreign investors in the Indian equity markets.
Weakness in the system
This weakness in the mid-cap space was visible and quite apparent. And especially when volumes and participation in the market was low, mid caps were prone or susceptible to any adverse situation.
Initially in January and February the correction in mid caps started selectively where one or two companies were in the news for heavy selling, which later on spread to other counters when FIIs started withdrawing money from the Indian equity markets.
In the absence of real buyers, mid caps started to crack and operators took advantage of the situation. When the markets knew the prices were crashing, operators and market participants jumped into the wagon and shorted many stocks, especially in the futures and options segment, leading to acceleration in correction.
Is there more pain?
Now the real question is whether there is more pain in this space. There is a feeling among market participants that a lot of distress selling has already taken place. And since the prices are now stabilizing, share prices should not crash further. But that does not assure of any weakness, which is expected to continue.
There will be recovery and those whose stocks that were sold in a hurry due to lack of money will come back to cover them. But that also will initially happen in cases where there is value and fundamentals of companies are strong.
What can investors do?
At this point in time buying mid caps could be both an opportunity and a trap. Keeping these things in mind, investors should stick with quality and not jump to buy them just because the stock is trading at a lower price.
Instead, an intensive check on fundamentals of companies and valuations could provide some clue. Companies with high debt and excessive pledging of shares by promoters should be avoided.
Companies which have solid business in terms of assets, brand and cash flows should attract attention. Investors who want to avoid any decision making and go through the entire research process could probably take a different route. They can choose and invest in a good mid-cap mutual fund scheme, which has a good track record in terms of performance, especially during the recent carnage in the mid-cap space.
There is a belief that may be over the next one year mid caps may not perform well given the several issues about liquidity, participation and fundamentals of the company and economy, but valuations at which some of these companies are trading are at a historical low. This is why, from the long-term perspective, these could be attractive options compared to their large-cap peers.
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