>INDIA INSIGHTS (HSBC)

• Overweight mid-caps relative to large caps
• Mid-cap stocks are trading at 10.7x 12- month forward PE, a 28% discount to large-caps
• Improving liquidity and growth prospects make them a compelling proposition.

Is mid-cap appeal back?

Following the recent 75% rally from the trough in early March, valuations are stretched; for instance, the Sensex trades at 16.2x 12-month forward PE. For investment ideas, we need to look beyond the frontline stocks — one segment of the market which is interesting is mid-caps, i.e., stocks with a market cap between USD500m and USD1bn. This segment started outperforming its large-cap peers recently and we would be overweight on a 6-12 month view.

The case for investing in mid-caps lies in cheaper valuations, trading at 10.7x 12-month forward PE, which is at a 28% discount to large-caps, while the valuation discount of midcap stocks tends to persist for a longer period of time. On average, in terms of PE, the discount is 17%. Consensus forecasts that mid-cap stocks will grow earnings at a CAGR of 16.2% compared to an 11.5% CAGR for large-cap stocks over March 2009-March 2011e. We believe this makes for a
compelling case for investment in mid-cap stocks.

Our study also highlights that this segment of the market has outperformed large-cap peers historically, and the outperformance is significant on a risk-adjusted basis with a Sharpe ratio of 0.2 vs. the large-caps’ at 0.14. For specific ideas, we provide a screen of stocks from our coverage.

The risks of investing in this segment relate to higher liquidity risk for mid-caps and higher leverage.

With this edition we are launching our new biweekly equity strategy product, India Insights.

To see full report: INDIA INSIGHTS