Are Large-Caps the New Value Picks? Pankaj Tibrewal Busts the Valuation Myth

In a market that has now turned into a stock picker’s one with narrowing choices amid hot valuations across most pockets, money managers have time and again vouched for large-caps as the preferred choice over small and midcaps. They often base their argument on the relatively reasonable valuations of blue chip stocks over their broader market peers, combined with the ability of large businesses to sail through turbulent times with greater ease.

However, the question that remains is whether large-caps actually offer cheaper valuations when compared to the small and midcap counterparts drowning under the image of being expensive. Market veteran and  CIO of IKIGAI Asset Manager, Pankaj Tibrewal breaks the myth in his latest quarterly newsletter to shareholders.

Tibrewal argues that even though at first glance, large caps might appear attractively valued, a closer look tells a different story. He sheds light towards the Nifty 50’s profit pool, which shows that 15% is contributed by Oil and Gas majors, 9% by PSUs (excluding banks and O&G), and 28% by banks (PSUs as well as private), all of which combined makes up to 52%.

On the flipside, Tibrewal highlights that the market cap contribution of these three segments in aggregate is 39% as they trade at lower PE multiples and when adjusted for these low PE segments, the Nifty 50 index trades at 26x 1 -year forward PE.

“This compares to Nifty Midcap 150 at 23x as the contribution of low PE sectors is lower. In other words, large caps aren’t quite as cheap as they seem. The broader valuation comfort comes largely from a few sectors, not the index,” Tibrewal explains.

He further goes on to add a key tailwind for the broader market that has emerged after the recent market cycle--a sharp decline in solvency risk among mid- and small-cap companies. Unlike in previous cycles where these segments often carried higher financial risk, many businesses have, over the past two decades, strategically used periods of strong cash flow to fund growth internally, he stated.

Now what that means is, this pocket of the market has reduced its reliance on debt and strengthened their balance sheets. As a result, net debt-to-equity ratios have steadily declined, reaching historic lows of 0.63x for mid caps and just 0.29x for small caps as of March 2024. Rounding that up, Tibrewal believes that small caps are now less leveraged than large caps, a key reversal from earlier trends. “This financial discipline has created a more resilient mid- and small-cap universe, far better equipped to navigate market volatility without the burden of weak balance sheets,” he added.

While small and midcaps faced the most brunt of the recent market downturn, Tibrewal went on to argue that the evolution of the market suggests that size no longer defines strength, but rather resilience and relevance do." As the market evolves, so should the lens through which we view these businesses,” he advised investors.

Taking on that idea, Tibrewal also shared his strategy when looking at stock picking within the current market. He said that his investment thesis is focused on picking companies that hold strong or leadership positions in their respective sectors backed by strong management teams and promoters. “These are businesses we believe can not only withstand the current environment but also grow or maintain their market share over time,” Tibrewal expressed.

Lastly, Tibrewal also shared some wisdom for investors, especially those entering the market at turbulent times. “Our advice remains simple: invest steadily, think long-term, focus on asset allocation and let time and discipline do the heavy lifting. We remain patient and focused-backing businesses built for cycles, not headlines,” said the market veteran.