The big question in everyone’s mind looking at the broader market underperformance is whether this is a shakeout, a distribution or a big correction? Your view?
A lot of investors have pledged their midcaps and borrowed against these shares. A lot of it is bloodletting because this is a pure leverage issue in the market. Secondly, shedding 5%, 10%, 15% is nothing for this market because the midcaps and the micro caps have grown 100%. So, the issue is not that the price fell by 5% or 10%, the issue is when those stocks get locked into the circuit filter, there is no exit. Some of the bigger stocks which have fallen 10-15% can be handled because those people can at least exit the shares.
But one cannot exit the micro caps. So, it is not about the price correction. But a fall of 5% on an index which has gone up by over two or three times in the last one year is hardly anything, even 10% or 20% for that matter. The issue is can you get out of the stocks?
Whether or not you can get out of the stocks comes a little bit later. But what is leading to this step down given that it is only 5% in the context of the gains that the mid and the small cap indices have seen?
It always starts from nervousness. The last two IPOs have left the investors broadly nervous about the market. Let us see what happens to the current IPOs. Two of them are quite weak IPOs at this point of time. What happens to them post listing? One, the nervousness started last week from the IPOs, saying the market is topping up. Next, in some of the stocks, the exuberance of the investors was amazing.
It is absolutely amazing. There were stocks in the midcap category which were running up in PEs of 90-100 and thereabouts. There was a problem there in terms of valuation. Who was buying this at those valuations? So there is partly a constructive correction on the valuation perspective but really speaking, the issue is we were expecting the June quarter results to be bad and they come out to be relatively bad compared to March across the board. I do not think any company literally has run a better result, apart from
which booked an extraordinary profit. But everybody has got a bad result for June quarter quite expectedly and that has caused a nervousness in the market.
If this recovery does not take place, what happens? Stocks like Sequent Scientific have good pedigree. They ran up too fast compared to the profitability of the company. Part of the correction trigger was the IPO nervousness which hit the market next week.
How different is this from the 2017-2018 midcap meltdown? What is the resemblance and what is the difference let me rephrase it this way?
The regulatory mechanism has been strengthened compared to 2017-2018. So margin, payments, leverage control are the strong point of this market. People are not going to overexpose. If the market does not have a systemic issue with the exposure to the midcap, that is the good part of it. The second good part is that in 2017-2018 and post that, most people in mutual funds had not made money on midcaps at all and lost tonnes of money in smallcaps.
They have recovered quite a bit of money in the last few years. So, the resilience quotient is quite high at this point of time but the question is whether this is a longer term trigger. We believe it is a longer term trigger because there is now a recognised reality of the valuation of these stocks that is coming to the market across the board.
When one runs with PEs of 30s and above and book values of 10 and above on a midcap stock, then one is really playing with fire. I think the correction in most stocks will be a little more longer term. It will take a while to come back. It will need the next quarter result to strengthen the belief back into some of the stocks.
Thirdly, the IPO market is controlling the sentiment. If the IPO market wobbles and the sentiment wobbles, it does not matter what the fundamentals are as the market wobbles for these stocks.
The last point is for people who are stuck with large caps. But other than banking which we have been saying is going to be a problem area, all other largecap stocks have done well — be it is steel, commodities, IT, pharma or FMCG. So the relatively safer larger caps mean less risks and they give decent returns. That makes one wonder why one should be sitting with a volatile portfolio at this point of time.
For those who own mid and smallcap stocks, what is the best way to use this selloff to their advantage?
I do not know what your definition of small cap is but we believe that companies with a turnover of less than Rs 250 crores odd would constitute that turnover basis. You really need to work very hard to locate those five cases out of the Rs 250- 400 crore universe to make a killing out of it. Most likely you will have one winner and four losers in that.
We believe that in our portfolio, we should not have anything from that sector. It does not matter what that company is. If it is listed and still has a turnover of less than Rs 250-400 crore and has been in existence for maybe a decade or so, you do not need to be in that company in the first place. That company has no future. If it could not do it in 10 years, there is no chance of it doing it in the next 10 years. Leave it to the realm of the speculators.
Now come to the sector which is Rs 400 crore and above and that is the sector to play with. Auto ancillary for example is a very strong sector because it is selling to a large market in an export pool and one can be safer in this sector.
In the case of chemicals, there have been a lot of tariff barriers for which government benefits have been given to chemical companies and therefore you can be safe in the chemical companies.
In the pharma space, the API space unfortunately has got a premium valuation compared to last 20 years’ average. You want to stay away from the API space in the pharma for some time to come, if the company is about Rs 400-450 crore. If you have got a company which is in specialty chemicals, you can do it.
So one can be in auto ancillaries, specialty chemicals and a little bit of retail. But roughly speaking, one should not be part of anything below Rs 400 crore turnover. One must have a very good reason why it has to be in the portfolio unless they belong to auto ancillary and specialty chemical and specialty pharma segments.
