Mean reversion? Nuvama suggests 7 smallcap, midcap stocks for solid gains

Most of the parameters are now moving in favour of small and midcaps (SMID) after the underperformance in the past few quarters. Brokerage Nuvama Institutional Equities believes that SMID valuation premium/discount are back to historical mean, after being higher around December 2021. The BSE Smallcap and BSE Midcap indices have gained 1 per cent and 5 per cent since December 31, 2021, while the benchmark equity index BSE Sensex advanced 7 per cent during the same period.

Stocks to buy

Considering the present market conditions, Nuvama has picked Polycab, Coforge, Blue Dart, PI Industries, RK Forgings, KEI Industries and Mahanagar Gas as top picks in the SMID space.

“At this point, we believe that we are more than halfway through this time’s SMID mean reversion cycle, and hence, even if it is not the time to go all out with smallcaps collectively, we are getting close to that point,” Nuvama said in a report.

The brokerage further added that the pace of earnings downgrades slowing down. It believes that this is somewhat a middle stage usually where the downgrades continue but slow down, before eventually reaching a point over the next one year when trends of earnings upgrades start again.

Multibagger on D-Street

Nuvama in its report added that India is a growth economy and ideally, investors try to identify businesses with earnings and cash flow growth rates that are 15 per cent plus. When coupled with valuation re-ratings, such businesses have proved to be multibagger stocks over the years.

But, for this 15 per cent plus growth, companies need to reinvest in growth constantly. “We have seen strong operating cash flow (OCF) generators being able to plough back the cash flows in capacity expansion and growth avenues, capitalise on growth opportunities in their sectors and hence grow faster over a number of years - even if the free cash flow generation (FCF) is negligible during these years,” Nuvama said.

Why OCF matters more?

Take example, India’s specialty chemicals companies grabbed the China plus one opportunity with both hands, through reinvesting their OCFs, managed to grow their multiple times over and as a result turned out be multibaggers during the 2014-21 period.

Value Re-rating candidates

The report further showed that names like Mahanagar Gas, Coromandel International, Federal Bank, CESC, Sterling & Wilson, Crompton Greaves Consumer, HPCL and Max Financial are among the potential value re-rating candidates.

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