Should you buy small and midcap stocks? Recent performance may continue, check top stock picks

With the broader market participating in the recent stock market rally, small and midcap stocks have surged. At times, midcap and small indices have even managed to outperform the benchmark indices. Between October 1 and yesterday’s closing Nifty 50 has gained 14.8%, going from 11,300 levels to 13,000. On the other hand, the Nifty Midcap 50 index has managed to zoom 15% in the same time period. Abundant liquidity, and healthy balance sheets are the key factors that are aiding the move towards midcap and smallcap stocks, analysts say.

Small and midcap stocks shine bright

“At this moment markets are being flooded with liquidity making it a liquidity driven rally,” Vishal Wagh, Head of Research, Bonanza Portfolio told The Outlooker Online. He added that apart from the liquidity factor, what is aiding the small and midcap stocks is their improved organisational effectiveness. “Firms in the midcap and smallcap space have worked towards maximising output without incurring additional costs which they have showcased in their balance sheets,” he added.

With healthy balance sheets and cost reductions, smaller firms have beefed up reserves to tackle any second wave of lockdowns that might be coming their way. Earlier in August global brokerage and research firm Morgan Stanley had said that after their struggle post 2018, it was now time for small and midcap stocks to shine. Then again this month, Morgan Stanley said that small and midcap stocks are likely to be in focus in 2021. “Small and midcap valuations are looking attractive relative to GDP and money supply, setting the stage for outperformance versus large-cap stocks in the coming months,” they said.

Where to invest?

Brokerage and research firm Edelweiss Securities, post the July-September quarter results has seen a 5–20% earnings upgrade for financial year 2022 for nearly 63% of stocks small and midcap stocks under their coverage while another 10% of such stocks wallowed in more than 20% earnings upgrade. Edelweiss noted that consensus estimates were beaten by most of the small and midcap stocks owing to faster than anticipated recovery. Their model portfolio has outperformed small and midcap indices by 4% over the last 12-18 months. Now, the brokerage firm is focusing on recovery plays as it tweaks its portfolio.

“We tweak the model portfolio a bit more towards ‘Warriors’ (i.e. recovery plays, turnarounds) as we believe sequential improvement trends should continue to have a bearing on stock performance,” Edelweiss said. It includes Blue Dart, Bharat Forge, Gujarat Gas, Crisil, Essel Propack, Teamlease, MMFS, LTTS and Mindtree into the portfolio while excluding IGL and L&T Infotech, GSPL, Dr. Lal, Dhanuka, MGL and Galaxy. 

Vishal Wagh is of the belief that fundamentally strong stocks should be looked in the midcap and smallcap space keeping in mind how they fare with the pandemic. “Midcap IT, Smallcap IT are good to invest in, stocks that are concentrated towards FMCG products too can be looked at. Investors should avoid transport and multiplex stocks,” he said.