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On the cusp of a Bull Market in mid cap stocks

While predicting winners is inherently risky, we find that sectors like real estate (RE), staffing companies, and companies with internet and Mobile driven business models are positioned quite well

Anil Sarin | December 4, 2019 | Updated 11:54 IST
On the cusp of a Bull Market in mid cap stocks

Market environment for the past two years reminds one of a memorable quote from a Charles Dickens classic - "It was the best of times, it was the worst of times". Through these lines, Dickens asserts his belief in the possibility of resurrection and transformation. When viewing the current economic conditions, it pays to remember that long-term returns from Indian equity markets have been decent, ranging between 14% and 17% for different time periods.

But what really matters to investors is their own portfolio returns, not index returns per se. For example, while the Index did well during 1999 to 2000, investors with large exposure to IT, Media and FMCG stocks earned much better returns. And their outperformance started well before the bull run.

Similarly, the mega bull market of 2003-2007 saw the Nifty index rising six- fold, compounding at 42% per year for five years. Within this overall good performance, capital goods and EPC companies had a particularly good run. While Nestle went up 3 times and Asian Paints rose 5 times, EPC companies on average went up 40 times.

In later years, pharma companies have outperformed during FY09 to FY15, and NBFCs have had a great run during calendar '16 and '17. The short point is, while equity markets have their ebbs and flows, it pays to be invested in the 'right' sectors during bullish periods. Another truism of the markets is that leaders of previous bull run seldom lead the subsequent bull run - IT sector never really regained its mojo after the Dot Com bust, EPC companies did not participate post 2008, and the recently outperforming NBFCs have been having a rough ride in the past year and a half. So as we contemplate the coming bull market in mid-caps, which are the exciting sectors?

Potential Multi Baggers

While predicting winners is inherently risky, we find that sectors like real estate (RE), staffing companies, and companies with internet and Mobile driven business models are positioned quite well.

Real Estate

In the case of Real Estate (RE), GST and RERA have given a huge boost to organised players. Until recently larger RE players had minuscule market share, but recent changes in accounting rules, combined with brand strength and access to low cost capital have tilted the scales decisively in their favour. In FY19, overall RE volume sales went up only modestly at industry level, but leading RE players (meaning the top 8 listed players) saw 65 percent volume growth.

This indicates sharp improvement in incremental market share. Well managed RE projects typically deliver RoE of above 20 percent. With the sector slowly seeing a revival and with sharply increasing market share, organised players should deliver several years of profitable growth.

The gloomy commentary on RE is keeping equity share valuations cheap despite vastly improved prospects, which makes the RE sector an even better investment. Staffing Staffing companies provide temporary workers (accounting, IT system maintenance, payroll processing, house-keeping, security, catering etc.)  and have proved to be big money-spinners in developed markets. Staffing companies are asset-light, delivering core RoCE (return on capital employed) in excess of 30 percent and enjoying multiple years of income once they start with a client.

As such, they are popular with investors looking for high RoCE, annuity-like revenues. India's journey of staffing is still nascent, and many decades of growth lie ahead. While Japan and US have more than 2 percent of labour force as temporary staff, that ratio is more than 3 percent for China. In India, it is less than 1 percent. Listed players like Quess, Team Lease and SIS have established strong leadership in this fast growing market, and their current valuations leave a lot of scope for improvement.


Digital business model (DBM) companies have delivered great returns in developed markets. In recent times, India too is starting to see listed companies like Info-Edge, IRCTC, Just Dial, IndiaMart etc, who leverage the internet and mobile to deliver solutions for customers. While small sized at present, DBM companies have great potential as Indians increasingly adopt internet and mobile in their daily lives. DBM companies typically have very low working capital, very little fixed capital investment and enjoy high returns on capital. They have high entry barriers due to the 'winner take all' dynamic where existing traffic brings more traffic and more traffic brings even more traffic.

Competitors have to spend a lot of money to break into the leader's client base, and find it easier to simply acquire the emerging leader while it is still small. So an interesting game is on, where legacy players and private equity funds are looking to acquire listed DBM players, and the DBM players themselves are using their free reserves to acquire stakes in emerging leaders. This makes it attractive for equity market investors to invest in DBM companies.

During fearful times, professional investors typically indulge in 'herding' behaviour. They might even wilfully ignore good opportunities because other fund managers are not buying them. This potentially provides an opportunity for thoughtful and patient investors, since consistent free cash flows eventually convince and convert all sceptics. There is a popular saying that 'a bull market climbs a wall of worry'. As India gradually emerges from a severe downturn, mid-cap investors in promising sectors should significantly outperform in the coming bull market.

Anil Sarin is ED and CIO - Equities at Centrum Broking

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