Valuation Correction on the Horizon? Nippon India’s Rupesh Patel Weighs In on Midcaps Amid New Index Highs.
While the midcap index flirts with new peaks, strong corporate earnings have helped cool down previously stretched valuations. An analysis of the resilient Q4 FY26 earnings season by Rupesh Patel, Senior Fund Manager – Equity Investments at Nippon India Mutual Fund, highlights how a bottom-up investing strategy can assist investors in identifying reasonable entry points amidst prevailing geopolitical and macroeconomic headwinds.
The Nippon India Growth Mid Cap Fund has shown a robust performance, delivering a strong 22% return over the last five years, outpacing the benchmark. However, in light of a Growth at Reasonable Price (GARP) philosophy, Patel discusses the challenges in finding “reasonable” valuations within a midcap market that many analysts deem overheated. While the NSE Midcap 150 index has remained relatively flat since September 2024, corporate earnings during this period have experienced consistent growth. Midcaps as a category have proven to be resilient, exhibiting higher growth rates compared to other segments of the market. Consequently, although valuations appear higher in relation to long-term averages, they have rectified since September 2024.
In the context of the Nippon India Growth Fund, the portfolio is constructed using a bottom-up approach where stocks are selected based on their relative risk-reward attractiveness. Some businesses within the midcap space may seem expensive in the near term; however, the potential of these companies to sustain earnings growth at a reasonable pace over the medium to long term renders them appealing investment choices.
When examining the sector allocations within the midcap fund, Nippon India is overweight on financials while being underweight on technology. The rationale for this investment strategy is anchored in their substantial exposure to well-capitalized lenders and beneficiaries of the financialization of savings, including Life Insurance companies and asset management firms. On the lending side, the fund’s exposure primarily involves institutions that are expected to maintain robust asset quality, healthy returns on assets (RoA) and equity (RoE), alongside reasonable valuations relative to the broader market.
In contrast, the underweight stance in the technology sector can be attributed to concerns regarding a slowdown in earnings growth caused by ongoing geopolitical uncertainties and disruptions such as artificial intelligence (AI). Valuation challenges also presented a concern until recently. As the sector grapples with transformation and adaptation to these new realities, a potential recovery in growth from current lows is anticipated. Companies in this sector, known for their capital efficiency and ability to generate free cash flow, could become attractive once valuations adjust favorably.
The Q4 earnings season for midcaps has demonstrated resilience, with most companies delivering results that meet or surpass expectations. However, Patel notes the ongoing risks associated with a deteriorating macroeconomic environment, cost inflation, and logistical challenges. The persistence of geopolitical uncertainties necessitates caution regarding their potential ramifications on earnings and valuations. Notably, midcap companies have showcased strong earnings growth during this period, further justifying their position in the investment landscape.
Given the diverse landscape of midcap companies, which spans multiple sectors and includes unique, rapidly growing profit pools, significant opportunities for investment remain achievable via a bottom-up approach. Patel articulates an awareness of the macroeconomic risks, including inflation challenges and logistical hurdles stemming from the ongoing geopolitical climate, while also recognizing how stock prices may already reflect these uncertainties.
When considering a 3-5 year perspective, Rupesh Patel identifies financials, consumer discretionary, and select industrials as promising sectors. Within financials, there remains a favorable outlook for lenders and businesses poised to benefit from the growing trend of financialization of savings. This encapsulates investments in insurance, asset management, exchanges, and other financial services, all of which are characterized by sound asset quality, healthy capitalization, and favorable RoA and RoE metrics.
In terms of consumer discretionary, growth is anticipated from favorable demographics, increasing per capita incomes, and premiumization trends across various categories. The industrial sector is underscored by the Indian government’s initiatives aimed at promoting manufacturing growth. Select companies in auto ancillaries, electronics manufacturing, precision engineering, and defense-related segments show promising potential. It is imperative, however, to carefully evaluate individual companies based on manufacturing capabilities, management strength, and cost competitiveness to identify true winners within these broad sectors.
Despite the midcap index nearing an all-time high this month, ahead of both small and large caps, the performance has seen flat returns over the last 20 months. This resilience, along with the superior growth rates reported by midcap companies, suggests that current valuations are relatively attractive due to time correction. Analysis of growth over the previous three years indicates that midcap companies have consistently outperformed broader market indices in terms of earnings growth. With a continued positive outlook for future earnings growth, the midcap index’s performance is largely reflective of its underlying earnings trajectory.
Source: The Economic Times
(Expert Note: This report was prepared by the Wealthova team.)