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S. Vaidya Nathan

MID-CAP stocks delivered attractive returns in the bull phase in the first half of 2002 as well as in the current run-up. But it is important to have the discipline to book profits with targets set for returns.

This assumes importance for one reason. When the funds that might also be chasing these stocks begin to pull out, even in a modest way, the downside risk can be substantial. Most mid-cap stocks tend to oscillate in line with the fortunes of their industries — especially in businesses such as automobiles.

Towards large-cap status: The only way in which these stocks can deliver sustainable value over a period is by moving towards a large-cap stock status. This has happened in the past ten years in a small set of stocks, including Hero Honda, Dr Reddy's Labs, Ranbaxy and Cipla.

Scaling-up of revenues and earnings, credible earnings numbers, sustained investor fancy, improvement in liquidity with stock splits and bonuses, a steady rise in market capitalisation and better and consistently high trading volumes have been important to such a shift in category for these stocks.

From the present lot of mid-cap stocks, TVS Motor, Corporation Bank, Sundram Fasteners, Kotak Mahindra and MRF, to name a few, have the potential to move into a different scale in terms of market capitalisation and operation levels.

But the transition may be riddled with difficulties. It would also take anywhere between five and seven years, and companies cannot afford to miss out on any opportunities.

It cannot be predicted with great certainty either the time-frame or which of the candidates will make it. In this context, even in such mid-cap stocks of good quality as Sundram Fasteners, Corporation Bank and MRF, profit-booking on at least a part of your holdings at regular intervals may be the better option.

Bubble in the making: Some kind of a bubble could be building up as liquidity chases mid-cap stocks. Funds have been chasing mid-caps, particularly in the banking, auto ancillary and engineering sectors, apart from a more selective choice from other sectors.

In these three sectors, there is a good underlying story. But the risk is that with all the liquidity flowing into these stocks, the stocks may be rightly priced, or possibly overpriced in some cases, even now.

New terrain in banking: Especially in the banking sector, the valuation of stocks, with the exception of State Bank of India and HDFC Bank, has moved into uncharted territory. A series of favourable developments has helped. These include the steady lowering of interest rates, opportunities in housing and retail finance, debt buyback, securitisation powers that enable the repossession of assets (whether they get the money back eventually is a different issue) and modest improvements in NPA levels.

The consequent re-rating of the banking sector stocks is, to an extent, permanent. But even the likes of Corporation Bank and Bank of Baroda, listed for over five years now, are at price levels touched rarely in the past. A look at possible at investment actions:

Investors in Bank of India, Andhra Bank, Syndicate Bank, UTI Bank and IDBI Bank can stay invested as renewed interest may emerge in these stocks, priced now at lower levels.

Investors, especially those who had taken exposures in banking IPOs in the last two years and other bank stocks when they were at substantially lower levels, can contemplate booking profits in other stocks.

Liquidity in all banking stocks is good now and selling pressures will be absorbed without too much of an adverse impact on prices. Re-entry at lower levels can be considered.

Hankering for smooth ride: Auto-ancillary stocks have been at the forefront of the recent rally. The notable aspect is that the stocks of frontline auto companies such as Tata Engineering, Ashok Leyland, Hero Honda and Bajaj Auto have been more or less flat or enjoyed a modest upside.

TVS Motors and Mahindra and Mahindra are the only ones that posted sharp gains on the back of volume growth in motorcycles and utility vehicles respectively.

The April numbers for the auto sector indicate a mixed picture. Growth in commercial vehicles has been modest. But in two-wheelers, the motorcycle segment has witnessed a mere 4 per cent growth. The scaling-up of volumes in April by 28 per cent (year-on-year) in the cars segment is an offshoot of the excise cuts.

Buyers may also have advanced purchase decisions to avoid the possible price increases that may be effected later in the year. The April growth rate may thus be sustained for another month or two. Then the rates can be expected to taper. But this one-time spurt has lifted the scale of operations. This may be reflected favourably in auto ancillary company revenues and earnings for the April-June 2003 quarter. But the pace may not sustain for much longer unless other auto segments also perk up.

The effect of last year's drought and the possibility of a deficient monsoon this year loom as risks. In this backdrop, any further spurt in valuation levels should be used to book profits.

This is important as even feeble signs of a continued slowdown in demand growth may magnify the downside for auto-ancillary stocks. Re-entry can be contemplated if there is evidence that the monsoon would not have an adverse effect on demand.

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