PMS Bazaar conducted another episode of the Sundaram Alternate Series -Season 2- Episode 8 “Secrets to Invest in Midcaps - Fund Manager Strategies for Midcap Investing”.

In our recent high-impact webinar on Midcap Investing, two industry veterans shared valuable market perspectives and investment strategies. Mr. Arjun Nagaraj, Chief Economist and Communications Manager at Sundaram Alternates Assets, led an illuminating discussion with Mr. Madanagopal Ramu, Head of Equities and Fund Manager at Sundaram Alternates Assets. This blog distills the essential insights and actionable takeaways from the insightful session that can shape your midcap investment approach.

Excerpts from the webinar:

Mr. Arjun Nagarajan began the conversation with Mr. Madanagopal Ramu by expressing that it was a perfect day to start their discussion. He noted that, as they were speaking in 2025, the Nifty had corrected by roughly 8%, the midcap by around 18%, and the small cap by approximately 22%. He then quoted veteran investor Warren Buffet, who said, "Be fearful when others are greedy and greedy when others are fearful." He also mentioned Rothchild, who was credited with saying, "The time to buy is when there's blood in the streets, even if that blood is your own." Finally, he quoted Benjamin Graham, who said, "Purchase stocks like you purchase groceries, not like you buy perfume." Mr. Nagaraj suggested that the current market conditions could be seen as discount sales, similar to those on Amazon and Flipkart. He reintroduced Mr. Madanagopal Ramu, whom he referred to as "Doctor Strange" from the AAL series, known for his market forecasting abilities.

Introduction and Market Overview

Mr. Nagaraj stated that he was pleased to have Mr. Ramu present and expressed his intent to demystify the markets with short and crisp questions. He began by observing that during demonetization, everyone claimed to be an economist, and similarly, in the current market, everyone was a chartist and technical analyst. He noted that many market gurus had mentioned that the market's momentum was broken. He then asked Mr. Ramu two questions: how to interpret these statements about broken market momentum and how he viewed the current market.

Analysis of Market Momentum

Mr. Ramu responded by acknowledging the quotes from veteran investors and added a quote from Mr. Von Buffet: "Only when the tide is coming back, you'll see who's swimming naked." He pointed out that the market was in a phase where many people had become fund managers and were giving stock recommendations. He attributed this to the post-COVID influx of money, improved global liquidity, and India's benefit from the India-China situation. He further explained that domestic money had also flowed into the mid and small-cap space, leading to significant growth in fund management.

Mr. Ramu stated that the growth was partly due to earnings growth from the COVID recovery and India's filling of the capacity constraint created by China. He mentioned that India's exports had performed well, benefiting the mid and small-cap sectors. He added that the crash in commodity prices post-Ukraine war and India's economic growth had contributed to good earnings until the end of 2023. However, he noted that revenue growth had started to moderate, and India's growth had touched single digits in 2023. Despite this, the market continued to rise until December, with mid and small caps recovering in every fall.

Impact of Liquidity and Behavioural Science

Mr. Ramu emphasized the impact of liquidity and flows on the mid and small-cap space, describing it as a significant area of study for behavioural science. He opined that when liquidity multiplies the AUM of mid and small caps by five to six times in a short period, it indicates greed, which was prevalent until December. He stated that a correction was expected, but fear had not yet set in, although there were early signs of concern among investors. He explained that midcaps, due to liquidity and flows, tend to see their valuation premiums expand significantly compared to the Nifty, a pattern observed in 2014, 2017, 2021, and recently in 2024.

Valuation and Market Correction

Mr. Ramu highlighted that the valuation premium of midcaps had reached as high as 40% by the end of December, which was ignored due to continuous flows. He mentioned that his firm had taken a cash call and was currently sitting on 30% cash, considering it the best investment in the current scenario. He observed that the market momentum appeared to be broken due to FII outflows, and the market was transitioning from a flow-driven to an earnings-driven phase. He predicted that the days of narrative-driven stock price increases were over, and the market was moving towards a phase where earnings would be the key driver.

Shift in Market Dynamics

Mr. Ramu stated that the market was shifting from a passive and diversified style to a concentrated, focused, bottom-up approach. He noted that while domestic flows were still strong, they were expected to mellow down, and FII flows had created a broken momentum. He advised investors to focus on earnings and be happy when stocks with good earnings fell, as it presented an opportunity to buy more. He recommended a complete reassessment of portfolios and emphasized the need to adopt a new mindset, discarding strategies that worked in the past two years.

Reassessing Portfolios and Market Strategy

Mr. Ramu suggested orienting portfolios towards sectors and stocks with visible growth and advised against panicking and exiting the market. He pointed out that the current correction was sharp and fast compared to previous corrections. He stated that the topic "Catching the Falling Knife" was apt because of indiscriminate selling, and he was happy to see stocks falling, as it presented buying opportunities. He reiterated that the market momentum had shifted, and the styles that worked in the past were no longer effective.

Mid and Small-Cap Opportunities

Mr. Nagaraj then asked Mr. Ramu about his view on mid and small caps, given that his portfolios were balanced and not skewed towards large caps. Mr. Ramu explained that large caps had issues with earnings growth and did not represent the growing part of the country. He noted that Nifty's long-term average PE was around 18 times, while it was still at 19 times, and its earnings growth was low. He pointed out that 40% of the Nifty comprised low PE, low growth sectors, and another 20% comprised slow growth, high PE sectors.

Analysis of Nifty and Sector Performance

Mr. Ramu stated that 60-70% of the Nifty was either slow growth or low growth, and it was not a place to make big money in the next three years. He suggested reallocating portfolios within mid and small caps and some large caps, adopting a multi-cap approach, and reducing the number of stocks. He expressed optimism about a recovery in the economy by Q4, driven by government efforts to stimulate growth. He mentioned that the private sector's balance sheets were strong, and corporate leverage was low, indicating potential for capex.

Midcap Analysis and Growth Potential

Mr. Ramu described midcaps as a railway junction with two platforms: one for companies moving from small to mid to large cap and another for companies heading south from large to midcap. He stated that the latter had performed well in the past two years due to mean reversion and short-term cyclical factors. He emphasized that narratives had broken, and the market was moving towards a phase where good businesses with competitive advantages would thrive.

Earnings Growth and Portfolio Strategy

Mr. Ramu noted that even in the worst period for midcaps, 50-60 stocks were growing above 20%. He advised reassessing portfolios, reducing breadth, raising cash, and focusing on earnings growth. He pointed out that many clients' portfolios were heavily skewed towards PSUs, which had benefited from momentum last year. He stressed the need to reassess valuations and move away from narratives.

Identifying Growth Opportunities

Mr. Ramu highlighted that stocks with good earnings in Q3 should perform well, and the expected increase in overall earnings growth would further boost their performance. He mentioned that panic selling was creating opportunities, and investors should focus on companies with strong earnings and growth potential. He advised looking for opportunities in sectors where government was focusing on domestic manufacturing and where negative news had led to significant corrections in stock prices.

Market Outlook and Investment Approach

Mr. Ramu suggested that the major part of the correction had already happened, and it was time to start looking for good stocks. He advised preparing a list of stocks, cutting down on those with earnings issues, and focusing on companies with strong growth potential. He compared the market to seeds that would show their capability after the first rain, indicating that patience and a long-term perspective were crucial.

Focus on Key Themes for 2025

Mr. Nagaraj then asked Mr. Ramu about the key themes he was focusing on for 2025, based on earnings momentum. Mr. Ramu responded that the market would continue to reassess for the next 2-3 months and take a direction in the second half of the year. He suggested identifying winners in the first half and expecting returns in the second half. He advised focusing on sectors with negative noise that were turning positive, as they presented low-risk opportunities.

Quality and Management Criteria

Mr. Ramu emphasized the importance of choosing quality stocks with good management, reasonable ROCE, and strong balance sheets. He advised avoiding companies with poor management, low ROCE, and weak balance sheets. He reiterated that the focus should be on companies with reasonable balance sheets, good management, and reasonable ROCE.

Mr. Ramu stated the importance of betting on companies with reasonable ROCE and good management, especially in sectors where negative noise was subsiding. He pointed out that sectors like NBFCs, which had faced tightening lending norms and concerns over NPAs, were now showing signs of recovery.

NBFC Sector Recovery

He noted that well-run NBFCs could grow significantly faster than banks, with some achieving growth rates of 25% compared to banks' 12-14%. He also highlighted their superior RoA, with some NBFCs delivering 3.5-4% RoA compared to banks' 1-2%. He mentioned that these NBFCs, leveraging their capital, could deliver a minimum Roe of 18-20% and were available at reasonable valuations. He cited Bajaj Finance and Cholamandalam as examples of NBFCs that had recently performed well, delivering significant returns even during market corrections.

Government Support and Market Opportunities

Mr. Ramu stated that the government's recent relaxation of norms indicated a shift towards an accommodative stance, suggesting that the concerns about the sector were overblown. He acknowledged the noise surrounding MFI and unsecured loans but emphasized that opportunities existed in troubled waters, particularly in the banking sector. He predicted that the issues surrounding MFI and unsecured loans would subside in the next two quarters, presenting buying opportunities.

Retail Credit Cycle and Sector Themes

He expressed confidence that the retail credit cycle was not a long-term concern, as most books were refinanced within a year. He highlighted the attractive valuations and improving noise levels in the NBFC sector, making it a promising area for investment. He also discussed the consumer discretionary sector, focusing on urban consumption in high-income regions. He noted that this sector had underperformed due to increased savings but expected a revival with government tax benefits and repo rate cuts.

Infrastructure and Power Sector

Mr. Ramu highlighted the power sector within infrastructure as exceptionally strong, emphasizing its long-term growth potential. He pointed out the mistake of underinvesting during the COVID period and the current surge in demand, driven by factors like data centres. He mentioned the global power shortage and the need for new technologies to address it. He also discussed the turnaround of BHEL, attributing it to the absence of Chinese competition and improved margins.

Investment Strategy and Market Outlook

He advised investors to shift from general infrastructure stocks to the power sector, viewing the recent correction as a good entry opportunity. He identified NBFCs, consumer discretionary, and the power sector as key themes for investment, suggesting a one to two-year investment horizon for optimal returns.

Investor Takeaways 

Mr. Nagaraj summarized the key takeaways for investors as focusing on good businesses, strong balance sheets, and ROCE above 12%. He then proposed opening the session for Q&A.

Arjun Nagaraj's Economic Outlook

Before opening the Q&A, Mr. Ramu asked Mr. Nagaraj for his economic outlook. Mr. Nagaraj expressed optimism, citing the government's reflationary efforts and the expected improvement in GDP numbers. He pointed to the pickup in capex momentum and the positive impact of potential rate cuts.

Key Variables and Market Positives

Mr. Nagaraj highlighted currency fluctuations and crude oil prices as key variables to watch. He noted that potential increases in US crude oil production could lead to lower prices, benefiting India and emerging markets. He also emphasized the positive impact of RBI dispensations and rate cut narratives. He concluded that the economy was holding up well, and the worst seemed to be behind them.

Audience Questions

During the session, several audience members raised insightful questions, seeking Mr. Ramu’s perspectives on market timing, investment strategies, and sectoral outlooks. Below are the key questions and his responses:

Timing Re-entry into the Market

An audience member asked Mr. Ramu how he timed his re-entry into stocks that had fallen significantly, especially given his current 30% cash holding. Mr. Ramu responded that he used simple tools and that trying to catch the absolute bottom was unrealistic. He emphasized the importance of feeling comfortable with valuations, particularly for stocks he understood well and that had corrected. He suggested making the first leg of investment in those stocks.

He advised against investing in unfamiliar stocks during volatile periods. He noted that some good-performing stocks had always traded at a premium in the past two years, making them inaccessible to value-conscious investors. However, with recent sharp corrections, these stocks were now available at reasonable prices. He recommended activating research on these stocks, validating the investment thesis, and waiting for the right entry opportunity.

Technical Indicators and Market Confirmation

Mr. Ramu mentioned that he relied on technical indicators from his dealer, although he clarified that he was not a technical expert. He expressed his belief that fear could not dominate the market indefinitely and noted buying activity in NBFC counters, particularly small and mid-cap stocks, following the recent relaxation of norms. He stated that positive news flow and strong earnings growth in the next quarter would further confirm the investment thesis.

Valuation Convergence and Deployment Strategy

He indicated that he expected to deploy most of his cash before the end of the next quarter. He explained that if midcaps fell another 10%, their valuations would converge closer to the Nifty's. He provided a mathematical explanation, stating that the Nifty’s 40% representation of low PE companies resulted in a lower overall PE, while midcaps had only 15% representation of such companies. He argued that if the Nifty’s low PE representation was removed, the remaining Nifty traded at 25 times multiple. He concluded that as midcap valuations approached the Nifty’s, it would be a comfortable time to invest in midcap stocks, especially those heading north.

Prioritizing Factors for Midcap Stock Selection

An audience member asked Mr. Ramu to prioritize one factor among earnings growth, margin expansion, and cash flow strength for selecting midcap stocks. Mr. Ramu emphasized that earnings growth had to reflect in cash flows, making cash flow earnings growth the most important factor. He added that investors should focus on earnings and be happy when stocks with good earnings fell, rather than worrying about price declines.

View on the Cement Sector 

Another audience member asked Mr. Ramu about his view on the cement sector, which was described as a "dark horse" segment. Mr. Ramu explained the "dark horse" theory, which suggested investing in overlooked segments with potential for surprise returns. He acknowledged that the cement sector was currently facing challenges due to consolidation and expansion plans, which could lead to muted prices and ROCE.

However, he noted that ROCE had bottomed out at 7-8% in some companies, indicating that the worst might be over. He cautioned that price increases were currently only compensating for cost increases and that the ongoing consolidation might limit future price increases. He concluded that while the cement sector had potential, the risk of price suppression remained.

Investor Fear and Market Cycles

The next question asked by an audience member to Mr. Ramu was what was disturbing investors today and making them afraid to deploy money, given his experience with multiple market cycles. Mr. Ramu attributed the fear to the psychological impact of seeing stock prices fall daily. He reiterated his advice to focus on earnings rather than stock prices and to reconfirm investment theses.

He described his weekly practice of reviewing portfolio earnings growth with his analysts. He emphasized that indiscriminate selling created opportunities for those who focused on earnings. He cautioned against extreme optimism or pessimism, stating that India was a reasonably good growth story with its own strengths and challenges. He advised investors to focus on opportunities rather than worrying about the overall market.

Concluding Remarks and Investment Advice

Mr. Ramu ended by stating that it was easy to get paranoid but that the best money was made by being clear about investment goals. He emphasized that the market was starting to throw opportunities and advised against keeping everything in cash. He suggested putting some money on the table while also keeping reserves for future opportunities.

He advised against exiting the market after a 30% correction and reiterated the importance of focusing on earnings as the guiding light during volatile periods.

The experts covered more topics in-depth during the session. For more such insights on this webinar, watch the recording of this insightful session through the appended link below.

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