Kotak Institutional Securities has dropped mid- and small-cap stock recommendations citing "irrational exuberance" among investors as stocks from these two broader categories have surged in the last six months.
The primary driver of the rally appears to be "irrational exuberance among investors, with high return expectations (and purchase decisions) being driven by the high returns of the past few months," the brokerage said in a Sept. 11 note titled "Mad (-cap.) dash".
Nifty Midcap index has risen 20% and 32%, while Nifty Smallcap Index is up 23% and 35% in the past three and six months, respectively.
"We are dropping our recommended mid-cap portfolio since we cannot find too many stocks beyond the BFSI space that offer decent potential upside to our 12-month fair value," Kotak said. The non-BFSI stocks, according to the brokerage, are trading above their 12-month fair values.
"We have changed the portfolio frequently in the past few months to keep up with rampant stock prices, but have largely run out of options now," the note said. "It is obvious that we have not developed some special stock-picking skills recently."
Great History, Bleak Future
Amid weak consumption demand, the valuations of consumption-based mid-cap companies have remained "high" or have touched "historical highs" due to earning cuts. "We see risks of lower profitability and lower valuation multiples due to weakening business models (erosion of business moats of brand, distribution market structure and product)."
Mediocre History, Great Purported Future
Stocks in the "investment" sector including capital goods, defence, EMS, railways, real estate and renewables are the new favourites of retail and institutional investors, according to Kotak Institutional Securities. "We believe that market expectations for both revenues and profitability may be too optimistic across these sectors."
These stocks have delivered "eye-popping" returns in the past three-six months, led by the broader investment narrative. "We expect a decent investment cycle, but we are not sure about the quality of many of the stocks given their historical weak execution and governance track-records."
Moreover, many of these sectors fall in the business-to-government or business-to-business categories, which "raises issues around execution and profitability".
No History, No Future
The brokerage categorises "turnaround" stories of certain mid- and small-cap stocks in the "dubious" lot, questioning the market confidence in such stocks.
Many of these companies have been through serious operational and financial challenges, including bankruptcy, in the recent past, but the market has high hopes of these companies doing well in the future, it said.
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