Should You Be Investing In Large-Cap Stocks Now?

Historically, during periods of heightened market volatility, Large-Cap stocks have tended to outperform their Small-Cap and Mid-Cap counterparts. And as our analysis indicates, backed by strong corporate fundamentals, robust earnings growth potential, and supportive macroeconomic factors, large-cap stocks continue to offer investors a reliable avenue for long-term wealth accumulation 

Over the past one month we have seen a dramatic shift in the performance of the Indian equity indices. The dream run of the broader market is coming to a screeching halt. After witnessing a return in excess of more than 50 per cent in the last one year, these indices have generated negative return over the past 30 days and this has been so even on a year-to-date (YTD) basis as of March 14, 2023. So far, the going had been very smooth for investors. However, the confluence of various factors leading to volatility has now rocked the boat in the equity market. [EasyDNNnews:PaidContentStart]

Navigating in such volatile times is often a test of resilience and strategy. Historically, during periods of heightened market volatility, large-cap stocks have tended to outperform their small-cap and mid-cap counterparts. This phenomenon is often attributed to the perceived stability and established market presence of larger companies, which can offer investors a safer haven during turbulent times. However, the past year has presented a unique twist to this narrative. While the broader market indices have indeed outperformed large-cap stocks for a significant duration, recent trends have witnessed a reversal, with large-cap stocks showing signs of resurgence. This resurgence could indeed signal a potential opportunity for investors to reconsider their exposure to large-cap dedicated stocks.
 

Reversion to Mean

To gain insights into the relative return performance of large-cap, mid-cap and small-cap stocks, we conducted a historical analysis spanning back to the year 2005. This analysis focused on the return difference between large-cap stocks represented by Nifty 100 and mid-cap stocks represented by Nifty Mid-Cap 150, as well as the return difference between large-cap stocks and small-cap stocks represented by Nifty Small-Cap 250. Such a study provides a comprehensive understanding of the historical dynamics of return differences across different market segments, aiding in forecasting future return trends. 

The following table shows the historical statistics pertaining to the analysis of return difference between small-caps and mid-caps against the large-cap stocks, shedding light on their relative performance dynamics. 

The column titled ‘Statistics’ outlines various statistical measures calculated over the analysed periods. ‘Number of Periods’ denotes the total number of periods included in the analysis, providing the number of rolling periods taken into consideration. The ‘Mean’ represents the average return difference between the small-cap and mid-cap as against large-cap stocks over the specified period, giving a sense of average difference. Meanwhile, the ‘Standard Deviation’ quantifies the dispersion of returns around the mean, indicating the level of volatility or risk inherent in the return difference series. The ‘Minimum’ and ‘Maximum’ values reflect the lowest and highest observed return differences, respectively, providing insights into the range of historical performance. 

Additionally, the ‘Quartile 1’, ‘Median’, and ‘Quartile 3’ values represent the 25th, 50th (median) and 75th percentiles of the return difference distribution, offering further granularity on the data’s distribution and skewness. It is clearly evident that the return difference between the small-cap and mid-cap stocks relative to large-cap stocks is currently at an extreme level. With the current return differences standing at 27.9 per cent for small-cap stocks and 22.7 per cent for mid-cap stocks, well above their historical means, there are compelling indications of potential reversal. In the history of the last 19 years, only 14 per cent of time have there been such instances when the return difference between the small-cap and large-cap stocks has been so high. 

In the case of difference between the mid-cap and small-cap indices, the current level was observed only 10 per cent of the time. And therefore it is no surprise that the current return differences significantly surpass the median and quartile values, indicating a departure from the typical range of historical performance. Given these observations, there exists a strong possibility of a reversion to the mean, whereby the return differences between the small-cap and mid-cap as against the large-cap stocks normalise over time. As such, investors may anticipate a scenario where large-cap stocks could regain momentum and begin outperforming the small-cap and mid-cap counterparts once again. 

There are various other factors that may contribute to this shift. Primarily, large-cap companies often possess stronger balance-sheets, greater access to capital and more diversified revenue streams, which can provide a cushion against volatile times. Additionally, during periods of uncertainty, investors tend to flock to perceived safer assets, and large-cap stocks often fit this bill. Furthermore, the recent outperformance of large-cap stocks could also reflect the changing market dynamics and investor sentiment. As economic conditions evolve and global factors come into play, investors may reassess their risk appetite and gravitate towards more established, blue-chip companies.
 

General Election: A Key Driver

As India prepares for the upcoming general election in 2024, a sense of caution pervades the market. The outcome of this election is poised to be a watershed moment, exerting considerable influence on the Indian stock market by profoundly shaping investor sentiment and policy trajectories. Presently, the frontline equity benchmark indices, Sensex and Nifty 50, are experiencing heightened volatility, a trend expected to persist until the declaration of the general election results, anticipated around the first week of June. 

Following the elections, the government will delineate its agenda and priorities, offering clarity on policies. Such clarity engenders confidence among investors and businesses, stimulating investment and fostering economic growth. The 2019 Lok Sabha elections provide a pertinent example of this phenomenon, wherein the stock market witnessed significant fluctuations leading up to the election. However, upon the revelation of the election results and the mandate received by the ruling party, the market experienced a rally, buoyed by positive sentiment and expectations of continued economic reforms and policies. 

An examination of the stock market data spanning the last five general elections, namely, 1999, 2004, 2009, 2014 and 2019, reveals a consistent pattern. In the six months leading up to the election results, the Nifty tends to exhibit strong upward momentum. On a three-month basis leading into the election results, the Nifty 50 closed positively in four instances, with an average upward movement of approximately 10.7 per cent, as per a report by a prominent domestic brokerage firm. The most significant positive movement, around 25 per cent, was observed in 2009, while the lowest of 8 per cent occurred in 2019. In 2004, the index closed negatively, experiencing a downturn of around 10 per cent. 

It was primarily due to unexpected results witnessed in the general election. Nevertheless, it underwent a substantial recovery from June 2004 onwards, once a stable government was formed at the centre. The outcome of recent state elections provides insight into political stability for the forthcoming five years. This has instilled optimism among investors regarding the Indian markets, as evidenced by strong domestic institutional inflows.
 

Interest Rate: A Prominent Factor

Interest rates have surged to peak levels in India and globally, driven by inflationary risks, rising oil prices and geopolitical tensions. The Reserve Bank of India (RBI) has maintained the benchmark interest rate at 6.5 per cent since February 2023, indicating a cautious approach towards its monetary policy. Despite expectations of a reduction in the policy rate, the RBI has refrained from making any changes, citing concerns over inflation and economic growth. The RBI’s hands are also tied due to higher interest rate globally. Inflation in India is very much constrained. However, global inflation and higher rates elsewhere are constraining the apex bank to take assertive action on rate cuts. 

We believe that from the third quarter of 2024 we may see some rate cut in developed countries as well on the domestic front. A reduction in the key policy rate could lower the cost of borrowings for both corporate entities and individuals, potentially stimulating economic activity and boosting investor sentiment. The impact of interest rate movements on large-cap stocks can be significant, influencing stock valuations, borrowing costs and investor sentiment. Market analysts anticipate a potential softening of the RBI’s policy stance in the coming meetings, with expectations of policy rate cuts in the second half of calendar year 2024. Additionally, projections for GDP growth and inflation remain optimistic, albeit with a cautious outlook.
 

Large-Cap Valuations: A Comprehensive Analysis

For many, the valuations of the Indian stock market are stretched. As such, the Indian market has emerged as the most expensive large market compared to other global indices. With the Nifty’s trailing 12-month price-to-earnings (PE) ratio at 23.06 times, it has been higher for almost one-third of the time over the past 24 years. The market’s valuation premium compared to its historical average stands as the highest among the 19 largest global markets. However, despite the Nifty trading above its historical average, a closer examination reveals that it is still relatively less expensive when considering its standard deviation of 4.9 times from the mean valuation. This indicates that the Nifty has a head room of 25.8 times before it becomes overly expensive. If we analyse the historical peaks from where we have seen a sharp decline in Nifty 50, we find that we are not yet at an exorbitantly higher level. 

Despite the current valuations of large-cap stocks hovering above historical averages, it is imperative to note that they remain well within reasonable boundaries, with no indication of entering a bubble zone. The current price-to-earnings (PE) ratio of 22.92 and a price-to-book value (PBV) ratio of 3.88 indicate both falling within one standard deviation higher of their respective means. This suggests that while the valuations may appear elevated, they remain consistent with past fluctuations and are not indicative of unsustainable market exuberance. Furthermore, the minimum, quartile and median values for both PE and PBV ratios indicate a relatively stable distribution, further reinforcing the notion that the current valuations are not outliers but rather reflective of the prevailing market conditions so that we may witness strong growth going ahead.
 

The following table shows the important statistics of PE and PV of Nifty 50: 

The chart below depicts the journey of the PE ratio of Nifty 50 since the year 2000. It clearly shows that the valuation of large-cap represented by Nifty 50 is within one standard deviation of its long-term average.

The following chart shows the movement of another valuation metrics of PBV ratio of Nifty 50 since the year 2000. Even this valuation ratio shows that the large-cap stocks are trading at reasonable valuation.

Sectors in the Limelight

Within the large-cap space in 2024, several sectors stand out as promising avenues for investment. Key themes such as fiscal consolidation and continued capex-led growth shape the investment narrative, driving focus towards sectors poised for expansion and resilience. This analysis aims to dissect the various sectors and identify potential opportunities based on the prevailing market dynamics and future prospects.

1. Infrastructure — The government’s continued focus on infrastructure development, highlighted by increased spending and investments, positions the infrastructure sector as a key beneficiary. With fiscal consolidation and a prudent approach to capex, companies engaged in construction, engineering and related segments are poised for growth. The proposed investments in transport infrastructure projects, especially in Tier II and Tier III cities, are expected to drive demand for construction materials and services, benefiting companies in the infrastructure sector. 

2. Banking and Financial Services — The banking sector is experiencing robust credit growth momentum, particularly in the retail and SME segments, indicating healthy demand for loans. Despite a cautious approach to fiscal management, the emphasis on capex spending is expected to fuel credit off-take, supporting earnings growth for the banks. Additionally, the management’s optimism about growth momentum and healthy asset quality further enhances the outlook for the banking sector. 

3. Information Technology (IT) — The IT sector holds promise for 2024, driven by factors such as a favourable credit cycle, revival in corporate spending, and potential improvements in earnings trajectory. The anticipated soft landing in the US economy could expedite the conversion of deal wins to revenue for IT companies. Moreover, a reversal in foreign portfolio investor flows could provide an additional boost to the sector’s performance. 

4. Non-Banking Financial Companies (NBFCs) — NBFCs are well-positioned to capitalise on ample liquidity, particularly during the festive season and the upcoming election period in 2024. With a quick turnaround time and healthy balance-sheets, quality-driven NBFCs are likely to outperform, especially in the initial stages of an expanding capex cycle. Additionally, the sector’s resilience and ability to deliver incremental earnings growth in the BFSI segment further bolster its prospects. 

5. Manufacturing — The manufacturing sector is witnessing robust capex by businesses aiming to cater to increasing domestic demand. Despite a slowdown in exports due to weak global macro conditions, companies scaling up to meet domestic demand are expected to achieve steady earnings growth. The government’s efforts to position India as a global manufacturing hub further underscore the sector’s growth potential. 

6. Automotive and Ancillaries — The automotive and ancillary sector continue to exhibit resilience, driven by factors such as traction in high-end SUV demand, growth in MHCVs, and a gradual recovery in two-wheelers. Margin expansion, supported by the softening of raw material costs and emphasis on premium grade and electric vehicles enhances the profitability potential for ancillary companies. Steady sales volumes, driven by new vehicle launches and replacement demand, will further contribute to the sector’s growth trajectory.
 

Timing the Investments

When considering the broader economic landscape, the case for investing in large-cap stocks remains compelling. With strong corporate fundamentals, robust earnings growth potential, and supportive macroeconomic factors, large-cap stocks continue to offer investors a reliable avenue for longterm wealth accumulation. Additionally, in an environment characterised by low interest rates and ample liquidity, equities, particularly large-cap companies with established market positions, present an attractive alternative for investors seeking capital appreciation. 

Thus, while prudent risk management practices are advisable, the data suggests that large-cap stocks will retain their allure as investable assets. In fact, large-cap stocks will offer potential for sustainable returns amidst the current market environment. While large-cap stocks may offer relative stability, they may not always present the same growth potential as their smaller counterparts during the bullish phases. Nevertheless, we are at the fag end of a bullish phase and may see more normal returns now even during a volatile phase. Therefore, increasing exposure to large-cap-dedicated stocks may indeed be a prudent move in the current environment.
 

Methodology 

To come up with a list of performing large-cap stocks, we took into consideration five crucial parameters. The first includes market capitalization. The second, third and fourth parameters obtained from the Profit & Loss Account include Sales, Operating Profit and Net Profit. We have also taken into consideration the efficiency of the companies by analyzing profit margins. Lastly, we factored in the returns earned by investors by means of dividends. This is because we want investor-friendly companies to be featured on our list. Each parameter was then ranked by awarding it a carefully determined weightage based on its significance. We then segregated the companies into three categories as follows: 

Turnaround Performance: These companies include those that successfully managed to turnaround the losses incurred in FY22 into profits in FY23. 

Improving Financials: Although these companies still reported losses in FY23 as they did in FY22, they succeeded in reducing these losses by a notable amount. This indicates that they are on the road to recovery. 

Thriving Companies: This list includes all those companies that have seen their profits increasing on yearly basis for FY23. 

All the raw financial data is sourced from Ace Equity and price-related information is as of March 13, 2024.

Click here to download list of Large Cap Companies

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