Small-, Mid-Cap Stocks May See Correction After Earnings, Says Systematix's Dhananjay Sinha

Small- and mid-cap stocks may see some correction in the post-earnings season if the second-quarter results remain subdued as compared to their premium valuations, according to Dhananjay Sinha, head of research, strategy and economics, at Systematix Group.

Sinha advised investors to be selective on such stocks, saying that it is important to understand where the valuations are lying and how the earnings outlook would pan out.

"If you look at the valuation for the mid-cap, it's been roughly 50% higher. If you look at the benchmark, indices are 50% higher than the Nifty P/E (price-to-earnings ratio), which is currently trailing at about 23.5 times," he told NDTV Profit.

"I would say it is expensive relative to the benchmark index. I think what is also important is the sustenance of this valuation premium that the mid and small companies are enjoying," the co-head of equities said.

With the premium most small and mid-cap stocks are sitting at, there should have been a growth of over 20–30%, according to Sinha.

"Whereas what we find is that broadly across the sectors that we've looked at, there is a certain amount of pressure in terms of the top-line growth and demand scenario. There are some concerns over the margin pressure across larger sectors," he said.

Sinha predicted corrections in the estimates for the small and mid-cap companies on account of constraints in cash flow and top-line growth. He noted that these factors will also affect large-cap companies.

"So, we need to be selective on the mid and small-cap because the valuation premium that has been given can actually start to come off if the earnings are not commensurate to the valuation they are trading at," he added.

Sinha also advised investors to be cautious of investing in realty firms, suggesting that the recent strong performance is likely to be impacted by external pressures.

"I think the funding of some of the real-estate players by some of the finance companies is under a certain amount of pressure. There is a cash flow issue happening with the developer. So, I think we need to be cautious over there," he said.