You may read volumes on your favourite subject but unless you truly comprehend the message of the writer, your efforts go in vain. The same is true in case of investing. Savvy as well as novice investors seek information that will help them identify rewarding investment options.

However, it’s been observed that, no matter how much they read about it, they continue to make the same mistakes. You may know the safety measures, but still lose money because greed often overpowers sincerity.

For instance, largecaps appear cheaper than mid and small caps on valuations at the onset of 2016. However, investors have been flocking to midcaps, pushing the valuations higher. So much so that a few fund houses have stopped accepting fresh funds under their select midcap oriented schemes about 2-3 months ago. Investors still appear bullish and midcap oriented New Fund Offers (NFOs) have been getting a good response.

Why investors are bullish on midcaps?

Due to their inherent nature, midcaps are considered to have a higher return potential than largecaps. Indian equity markets have been in the bull phase since December 2011. Although they were corrected significantly in 2013; they bounced back. Thereafter, there has been no significant fall in the market. When markets are stable and largecaps get a little expensive; investors rushed to the midcap counters. However, many investors prefer to trade in largecaps but invest in midcaps simply because large caps have better liquidity than midcaps. In simple words, when needed, largecaps can be sold off quickly.
 

How are market valuations placed?

Data as on January 01, 2016
(Source: BSE, PersonalFN Research)

In the year 2015, FIIs invested cautiously in Indian markets. They withdrew their monies from Indian markets quite regularly in the second-half of 2015. They may have not been specifically negative but India as a market may have become less attractive. This caused largecaps to lose more than midcaps. In fact, while India’s bellwether index, S&P BSE Sensex lost approximately 5% in 2015; S&P BSE Midcap ended the year 2015 with gains of around 7%. As a result, Sensex traded at the PE (Profit/Earnings) multiple of 19.83 (on trailed earnings) as on December 31, 2015. On the other hand, the S&P BSE Midcap traded at the PE multiple of 26.57 on the same day. As you may be aware, lower PE denotes lower valuations. Clearly, largecaps appear more attractive at the index level.

 

Majority largecaps are trading at reasonable valuations...
As per data published by the Economic Times dated January 05, 2016, approximately 75% of large caps are now trading below their 5-year average PE. Interestingly, 55% of midcaps are commanding a higher PE multiple than their 5-year average.

However, this is not to say that all’s well with the large caps. A few largecap companies are in a debt trap, while a few others are suffering due to low commodity prices. Many large-sized Indian banks are still vulnerable to the problem of bad loans. Nonetheless, the universe of large caps is large enough for investors to find out reasonably valued largecap stocks at the current level. A caution here, large caps are widely researched and tracked therefore, in your individual capacity, finding a mispriced largecap stock is a challenge. Therefore, even with large caps you need to be careful. Unless growth of corporate earnings exceeds investor’s expectations, largecap stocks are unlikely to do well.

If you don’t have time or expertise to select stocks on your own, you may invest in largecap oriented mutual fund schemes. Best not to blindly trust any largecap fund, stick with the ones that consistently outperform their benchmark indices and other largecap oriented funds across timeframes and market phases.

PersonalFN provides unbiased research services that may help you select a suitable fund for your portfolio.

"In investing, what is comfortable is rarely profitable." - Robert Arnott

We invest to earn returns; for comfort, we buy the right clothes.

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