Investors watch the trading board at the Colombo Stock Exchange. (Photographer: Luis Enrique Ascui/Bloomberg News)

Mid And Small Caps Overvalued Despite Recent Correction, Says UBS’ Gautam Chhaochharia

Small- and mid-cap stocks continue to be more expensive than their large cap peers, despite the recent correction.

That’s the word from Gautam Chhaochharia, head of India research at UBS Securities. “Small-cap and mid-cap stocks have outperformed large caps in India generally and compared with past peaks or bottoms, but have recently underperformed, with more than 60 percent of the listed stocks down 20 percent from their peaks,” he said.

That underperformance is likely to continue. Even after the correction, the mid-cap index is trading at about a 20 percent premium to the Nifty on a forward earnings basis versus the historical average of trading at a discount, Chhaochharia told BloombergQuint in an interview.

The S&P BSE MidCap Index and the S&P BSE SmallCap Index have given negative returns of 6 percent in the past one month on account of concerns around the rejig in mutual fund schemes and additional surveillance mechanisms put in place by market regulator Securities and Exchange Board of India. Chhaochharia, however, sees no major role of these actions, in the recent corrections.

SEBI's stricter norms and mutual fund restructuring would have a role to play in select stocks not the mid-cap asset class, Chhaochharia said.

Rising Interest Rates Also A Factor

Rising interest rates have not traditionally impacted the performance of small and mid caps, but the story is different this time round, according to Chhaochharia.

As in many other parts of the world, small- and mid-cap stocks in India have outperformed large caps in a rising rates environment, Chhaochharia said. "Rising rates this time is not really counter-cyclical.”

Rich valuations, sharper earnings reactions in small caps versus the large caps and pullback in mutual fund flows have driven the correction, Chhaochharia said.

Watch the full interview here: