While large-cap stocks offer the advantages of consistency and scale, midcaps provide the comfort of cheap valuations and high growth. This is why fund managers have 19% of their equity assets, Rs 36,736 crore, in mid-caps and the mutual fund industry has increased its exposure to the Midcap Index stocks by 27% over the past year.
As the economy shakes off the slowdown, mid-caps offer the potential for faster growth compared with their large-cap peers. Mid-caps can also generate long-term wealth as over time these companies tread into the large-cap space.
In a prolonged growth cycle, like the current one in India, mid-caps tend to do better than large firms due to their niche presence. In the January-March quarter, the sales and profits of the BSE Midcap Index companies increased by a robust 20% and 28%, respectively.
An analysis of the last bull market (January 2003 to January 2008) will help us understand the market better. In April 2003, the NSE Midcap Index was available at around six times the PE compared with the Nifty's valuation of 13.4 times. As the economy entered the highgrowth phase, small companies were at the forefront of creating wealth. From a low of six times the PE, the Midcap Index valuation increased by over four times to a high of 25.8 in May 2006. In the same period, the Nifty PE rose from 13.4 to only 21.3.
This steep variation decreased as investors' risk appetite increased. As in the case of large-caps, we zeroed in on the stocks in which mutual funds have invested the most. These stocks are considered the top 10 by value of the mutual funds' holdings. We also identified the stocks that were bought most consistently by fund managers in the past one year.
This left us with another list of 15 stocks. The stocks in which mutual funds have invested the most are companies with consistent track records. Popular among them are Voltas, GlaxoSmithKline Consumer Healthcare, PTC India and Sintex Industries.
All the top 10 stocks have a history of low earnings volatility. Among the stocks that have caught the fund managers' interest, the most prominent is Polaris Labs. In May 2009, only one fund had invested in it.
As the demand for software services improved, fund managers bought 120 lakh shares of Polaris. This was an increase of 3,740% and, as of May 2010, 31 funds have an exposure to this stock. What attracted the interest is its robust deal record. In the January-March quarter, the company secured 22 deals in its products business, the highest for any quarter.
It has projected a 31-33% growth in the current financial year's earnings to Rs 20.2-20.5 per share. Another advantage the firm has is its cash and equity assets worth Rs 510 crore, which is Rs 52 per share. Anand Rathi, a research firm, says, "At our target price of Rs 250, the stock would trade at 12 times the estimated earnings of 2010-11.
At this valuation, Polaris would trade at a 40% discount to the average of the large-cap 2010-11 target multiple (20.5x)." Escorts, Bilcare and Petronet LNG are the other stocks that have seen a consistent rise in fund manager interest. Tractor-maker Escorts caught the fancy of fund managers after the restructuring of its balance sheet. From a minuscule holding of 0.8 lakh shares, the mutual fund industry increased its stake to 121 lakh shares, a rise of 15,433%.
In the January-March quarter, the company's tractor volumes went up by 51% to 14,623 units. This resulted in a 37.4% revenue growth. The company has also won an order worth Rs 185 crore from the government of Tanzania to supply 1,430 tractors from July. Analysts expect the company to report an earnings growth of over 25% in the current year.
The investors who have a time frame of three-four years can choose from these 25 stocks. The most wanted stocks by value offer consistency in earnings. The investors can pick one or two from this pack. For stocks that have the potential to outperform the broader market, investors can look to pick from the set that has seen a consistent rise in fund manager interest.
