PMS Bazaar recently organized a webinar titled “What is Next for Small and Mid Caps?” which featured Mr. Balaji Vaidyanath, Director, Fund Manager, CEO, CIO, NAFA Asset Managers. This blog covers the important points shared in this insightful webinar.

The webinar blog covers insights from Mr. Vaidyanath, where he covered key market trends, stock selection strategies for mid and small-cap segments, and the impact of market volatility. It explored the role of global events, sector rotation, and emerging companies like Amaraja Batteries and Thyrocare. Additionally, Mr. Vaidyanath discussed microeconomic factors, investment opportunities, and the evolving landscape of India's market and industries.

Key aspects covered in this webinar blog are

• Equity market overview: Lessons from recent trends.
• Mid-caps and small-caps: The NAFA perspective.
• Volatility and stock selection.
• The case of Bata: A lesson in delta change.
• The market downturn: Contributing factors.
• Unusual behavior of large-cap stocks.
• Changing role of defensive sectors.

Summary: Mr. Balaji Vaidyanath shared valuable insights on equity market trends, emphasizing the importance of stock selection, especially in mid-cap and small-cap sectors. He discussed market volatility, the impact of global events, and the need for thorough analysis using NAFA’s method. Mr. Vaidyanath highlighted the shifting dynamics of large-cap stocks, defensive sectors, and the role of sector rotation in portfolio management. He also explored emerging companies and microeconomic factors, stressing the significance of focusing on fundamentals for long-term growth.

Mr. Balaji Vaidyanath staretd the webinar by providing an insightful analysis of the market trends observed over the past few years. Sharing his observations at a recent event, he reflected on equity market performance, the role of corrections, and the importance of stock selection in mid-cap and small-cap segments.

Equity Market Overview: Lessons from Recent Trends

Mr. Vaidyanath noted that the past three to four years, barring the health-related disruptions caused by COVID-19, witnessed a stellar performance in the equity markets. He emphasized that these years allowed investors to compound wealth significantly with minimal portfolio disruptions. However, in October 2024, a market correction marked the first significant downturn in almost half a decade, serving as a reminder of equities’ non-linear nature. He pointed out that index-level corrections of 10–15% are part and parcel of investing in equities.

Mid-Caps and Small-Caps: The NAFA Perspective

Turning attention to mid-cap and small-cap stocks, Mr. Vaidyanath highlighted the NAFA (National Association for Financial Analysis) approach to analyzing these market segments. He shared data from 2024 to illustrate return distributions across different indices:

• NIFTY 100: 63% of stocks offered returns between -25% to +25%.
• MidCap 150: This percentage dropped to 57%.
• SmallCap 250: Only 46% of stocks fell within the same range, indicating greater return dispersion in smaller-cap segments.

This data, he explained, underscores the significance of meticulous stock selection, particularly in volatile markets.

Volatility and Stock Selection

The last quarter of 2024 was marked by heightened market volatility. Mr. Vaidyanath described how individual stocks corrected sharply by 40–50%, making careful analysis essential. He explained NAFA’s method of classifying companies into buckets based on profit growth:

1. Less than 0%
2. 0–10%
3. 10–20%
4. Greater than 20%

Using the footwear sector as an example, he showed how shifts in these categories signal underlying changes. For instance, in the July-September 2024 quarter, four companies showed profit growth exceeding 20%, up from three in the previous quarter.

The Case of Bata: A Lesson in Delta Change

Mr. Vaidyanath elaborated on Bata’s performance as an example of the importance of delta change—the difference in growth rates over time—rather than absolute numbers. Bata’s EBITDA growth improved from -23% to -4%, signaling recovery despite remaining in negative territory. This delta change, he noted, makes the stock worthy of closer analysis.

He also highlighted that Bata’s price-to-sales ratio had reached a decade-low, presenting a potential buying opportunity. This analysis was conducted in November 2024, when Bata’s price was around ₹1,362. By January 2025, it had risen to approximately ₹1,450, validating the importance of recognizing early signs of recovery.

Key Takeaways for Investors

Summarising his insights, Mr. Vaidyanath reiterated the importance of:

• Acknowledging the cyclical nature of equity markets.
• Conducting thorough stock-specific analysis, particularly in mid-cap and small-cap segments.
• Focusing on delta changes rather than absolute metrics to identify turnaround opportunities.

He emphasized that these principles are crucial for navigating volatile markets and building resilient investment portfolios. Mr. Vaidyanath concluded by reminding investors of the need for patience and a disciplined approach to stock selection. While market corrections are inevitable, they also present opportunities for informed investors to identify and capitalize on growth potential.

The Market Downturn: Contributing Factors

According to Mr. Vaidyanath, the recent significant drop in the market can be attributed to multiple factors. He highlighted that the market was impacted by Foreign Institutional Investors (FII) selling, along with the turbulence caused by the US elections. Interestingly, over 60-70 countries had elections this year, and many incumbents lost their positions or faced a substantial reduction in their vote shares. Additionally, the regulatory crackdown on speculative activities has further added to market uncertainty.

The situation was exacerbated by a high inflationary environment, particularly with vegetable prices soaring. On top of that, macroeconomic concerns, such as the yen carry trade and a significant slowdown in the overall economy, with GDP plummeting to 5.4%, have compounded the downturn.

Unusual Behavior of Large-Cap Stocks

Mr. Vaidyanath highlighted an interesting anomaly in the market: large-cap stocks, typically more stable during downturns, have shown weaker performance than mid-cap and small-cap stocks in recent months. In most market declines, it is expected that mid and small-cap stocks would experience greater losses, while large-cap stocks, represented by the Nifty 50, should perform better. However, in this case, the Nifty 50 has witnessed a more significant drop compared to the broader mid and small-cap indices over the last three to six months, which is an unusual occurrence warranting deeper analysis.

Changing Role of Defensive Sectors

The traditional role of defensive sectors, such as FMCG (Fast-Moving Consumer Goods), as a safe haven during market downturns, has also shifted. In the past, investors flocked to FMCG stocks during market declines due to their stable performance. However, this time, even FMCG stocks have faced substantial drops, signaling a change in the market dynamics and suggesting that these sectors may no longer offer the same level of protection they once did during times of volatility.

Growth Beyond the Listed Market

Mr. Vaidyanath noted that while the Indian economy is progressing, the composition of listed companies in the Nifty 50 index has not changed as dramatically as the growth observed in unlisted sectors. Companies such as Apple, Microsoft, Dell, and YouTube have achieved impressive turnover figures in India. Apple, for instance, has reported a turnover nearing ₹65,000 crores in India alone, reflecting the rapid growth of these companies despite their large-cap status. This indicates a significant shift in the market, where growth is occurring not just within the listed space but also in the unlisted sectors.

The Evolution of India's Market Landscape

Over the last two decades, India has witnessed significant changes, including increased vehicle ownership and banking penetration. However, Mr. Vaidyanath pointed out that the composition of the Nifty 50 has remained relatively stagnant, even as various sectors outside the listed space have experienced remarkable growth. This contrast highlights a growing disparity between the listed and unlisted markets in India. While US multinational companies operating in India, such as those in the tech and manufacturing sectors, are rapidly expanding, their growth is not represented in the Nifty 50 index.

Challenges for Large-Cap Stocks

Lastly, Mr. Vaidyanath cautioned that the traditional investment approach of shifting from mid and small-cap stocks to large-cap stocks based on historical performance patterns may no longer be a reliable strategy. Many large-cap stocks, including market leaders like Reliance Industries, are facing substantial challenges. In particular, Reliance’s petrochemical business is encountering increasing competition, which could affect its market share and performance in the future, making it less of a safe bet compared to earlier years.

The Paint Industry Transformation

According to Mr. Vaidyanath, the paint industry, once dominated by a handful of major players like Asian Paints, Berger, and Kansai, has witnessed a significant transformation. New entrants such as Pidilite, Birla, JSW, and MRF have doubled the number of players in the market. This increase in competition has raised questions about whether these new companies will manage to carve out market share from the established giants. However, the impact on market share and whether this will lead to price and time corrections remains to be seen.

The Rise of Global Capability Centres (GCCs)

Another point Mr. Vaidyanath highlighted was the growing trend of global companies setting up their own Global Capability Centres (GCCs) in India. He noted that companies like Eli Lilly, one of the world’s largest manufacturing firms, are now setting up their GCCs in cities like Hyderabad. Once considered cost centers, these GCCs are now evolving into profit centers. Mr. Vaidyanath raised a crucial question about the sustainability of large orders and the future impact of AI and automation on margins and resource needs.

The Importance of Sector Rotation for Portfolio Management

Mr. Vaidyanath also stressed the importance of sector rotation in portfolio management. He provided data from the period 2014 to 2024, revealing how different sectors performed over various timeframes. For example, over a 10-year period, only about half of the sectors outperformed the market. He pointed out that sectors typically have an average outperformance period of about 2.8 years, after which their growth tends to stagnate. This, he said, underlines the importance of timely sector rotation for long-term wealth creation.

Investing in Emerging Companies: Amaraja Batteries and Thyrocare

In his investment strategy, Mr. Vaidyanath shared examples of companies like Amaraja Batteries and Thyrocare, which he added to his portfolio. He explained that Amaraja has gained market share at the expense of Exide, and the company’s expansion into new technologies, such as lithium-ion batteries, makes it an attractive investment. Thyrocare, a diagnostic company, had underperformed its peers for some time but has recently shown strong growth, outperforming companies like Dr. Lal PathLabs. According to Mr. Vaidyanath, the entry point for Thyrocare was attractive due to its undervaluation compared to its competitors.

The Focus on Microeconomic Factors

Mr. Vaidyanath also emphasized that in a volatile market, it is crucial to focus on microeconomic factors rather than macroeconomic indicators like GDP or interest rates. By focusing on market share growth and company fundamentals, investors can better identify potential winners. For instance, despite challenges in the SME sector, Thyrocare’s market share growth made it a solid investment choice.

Overview of Vimta Labs and Testing Industry

Mr. Vaidyanath shared insights on Vimta Labs, a company that recently entered the market at ₹720. He highlighted the growing importance of testing in India, driven by stricter quality control norms and standards. With increasing regulations by the Bureau of Indian Standards (BIS), testing will become mandatory across various sectors, making Vimta, a strong player in the market, a key beneficiary.

The Role of BIS in India’s Future Growth

He emphasized how BIS’s involvement will play a critical role in reducing imports and boosting exports, as seen with the cable and transformer industries. He believes testing companies like Vimta are well-positioned to thrive with India’s push for self-reliance.

Mr. Balaji Vaidyanath covered all the topics mentioned above in-depth and answered questions from the audience toward the end of 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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