The tantalising top ten

The largest of the large caps: we’ve talked about them several times in the recent past, and for good reason. These stocks have perhaps never had it so bad before. Not only has their weight in the total market capitalisation dwindled to an all-time low, but their relative price performance also hit an all-time low recently. This latter point can be observed in the chart below.

This spell of underperformance from the very biggest stocks might represent an excellent opportunity for investors, simply because a regression to the mean from this point is quite possible.

Consider the chart below, which plots the 1-year rolling alpha (i.e. outperformance) of the Nifty Top 10 Equal Weight index relative to the Nifty 500. The last time this rolling alpha was at roughly the same level as its current level was between 2007 and 2008: at that time, not only did its bottom serve as an inflection point, but it also bounced back very strongly over the next year, as can be clearly seen.

Moreover, the large addition to India’s overall equity market capitalisation from new listings has made the top 10 cohort even more attractive. This is because more than two-thirds of these new issues were listed at prices that were greater than 50x of their trailing earnings. As a result, this newly infused market cap component has a low profitability base when compared to the top 10 stocks.

Historically, periods of inflection in the underperformance of the 10 largest-cap stocks versus the rest of the market have coincided with a general ‘risk-off’ environment, i.e. during such times, investors have usually been especially keen on reducing their risk exposure and protecting their capital. Given recent concerns that the small- and mid-cap (SMID) category might be too frothy and overvalued, it’s possible that such a risk-off environment might be on the horizon.

Lastly, it’s important to note that on an absolute basis, even the top 10 stocks aren’t currently cheap from a historical perspective. Hence, they should be looked upon as a relative play for investors looking to add some equity exposure.

For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.