Should you be worried about valuation of smallcaps? | Economic Times

Players with strong balance sheets and strong brands in the midcap and smallcap space are gaining market share from unorganised players, says Aishvarya Dadheech, Ambit Asset Management in this interview. Edited excerpts:Let us start by understanding your thoughts on smallcaps. Do you find froth in valuations?Midcaps and smallcaps outperformed largecaps in calendar year 2020. We are seeing massive outperformance even this year as well. There is enough leg room for the momentum to continue. All three participants -- DII, FII and even retail -- have increased their exposure in this particular segment.If you look at the last five quarters, the ownership of DIIs in midcaps and smallcaps has moved from half per cent to 2.8 per cent; whereas FIIs have increased it from 2.7 per cent to almost 3.3 per cent. A large part of increment has happened on the smallcap side. Retail investors, who are leading this rally, have increased it from 3.1 per cent to 3.9 per cent. In the last 20 years, whenever the economic recovery has seen strong momentum, the broader market has done well. In FY22, the economy will possibly grow in double digits, and in FY23, it may grow by another 7-8 per cent. And then we have low interest rates. All this boards very well for midcaps and smallcaps. Are the valuations a concern? Yes, to some extent. If you look at the valuation of Nifty50 and compare it with Nifty Midcap 100, valuation is in line. Smallcaps are still relatively cheaper.You have to consider growth expectations. We are entering a very solid earnings growth momentum cycle which will be visible for companies across midcaps and smallcaps, alongside largecaps. To an extent, this earnings growth is justifying the movement that we have seen in the market. A lot of sectors have gained meaningfully from the Covid crisis. Players with strong balance sheets and strong brands in the midcap and smallcap space are gaining market share from unorganised players. Their trajectory is looking very promising and that justifies their valuations.How are you looking at the consumer discretionary space? Do you see a rebound in their business over the next few quarters?It is very likely that all contact-intensive sectors which bore the brunt of Covid will see normalisation. We have also seen RBI giving them liquidity to stand on their own. We believe that contact-intensive sectors which have been impacted the most will see a big mean reversion. One beautiful thing is that a huge amount of consolidation has happened. A lot of weak players which had too much leverage or had limited skills to raise money or limited brand or limited distribution channels have vanished. A couple of leaders in each and every segment will gain. So we believe it is going to be a beautiful trade to invest in sectors which will benefit once the economy gradually opens up over the next couple of quarters. This is one area which we believe is very promising.What is your reading of the earnings momentum?When we interacted with a lot of midcap and smallcap companies even before Covid 2.0, there was an uncanny optimism on the demand side. They were talking about a demand trajectory which was not seen in the last 5-7 years. They are preparing themselves to bring up the capex to meet the demand in the next 2-3 years.We believe inflation is quite manageable. People in equity always love inflation because healthy inflation is always conducive for higher earnings growth. It will remain very comfortable from equity market's perspective.