The Indian stock market moves in cycles. During each upcycle, relatively small firms from the small- and mid-cap (SMID) space exhibit stellar performance. As can be seen in the chart below, SMID stocks have significantly outperformed large caps (LCs) in every upcycle bull market so far.
Source: Bloomberg, BSE, DSP. Data as of Aug 2024.
What the above chart also reveals is that during each downcycle, SMID stocks lose almost all the alpha (i.e. outperformance) generated during the previous upcycle. This is consistent with the typical volatility that SMID stocks exhibit: their relatively higher volatility results in larger drawdowns during bear markets compared to the relatively shallow declines seen among large caps.
What does this mean for investors? Capturing the extra alpha that SMID stocks can deliver requires investors to focus on the margin of safety (i.e. the gap between a stock’s market price and its intrinsic value) rather than relying on recent outperformance.
In fact, it makes a lot of sense to have an aggressive attitude towards SMID stocks when their alpha over large caps is low. Currently, SMID stocks have a large alpha over large caps, so investors might be better served by focusing more on large caps.
For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.
Leave a comment