Market Strategy + Top Picks For 2016 By ICICI-Direct

In CY15, the BSE Midcap index outperformed by ~15% as the BSE midcap has delivered 7.5% returns while large caps delivered negative returns of 7.2%. Valuation wise, midcaps have started trading at a premium to large caps. The former is approaching all-time high premium that was witnessed in CY12

The key reason for the outperformance of midcaps is the fact that the positive Premium/discount of midcap valuations over large cap valuations impact of operating leverage lower input costs) and financial leverage (improvement in working capital and decline in interest rates) has been more profound vis-à-vis large caps. This trend is expected to continue on the back of an incremental fall in input costs and likely reduction in interest rates in CY16E. The same is reiterated by the 24% earnings CAGR for midcaps vs. 18% for large caps in FY15-18E

Going into CY16E, we believe the outperformance of midcaps may continue but the action may get concentrated as valuations are becoming expensive, The midcap index is trading at 16.1x on FY17E EPS, in that universe. So, one has to be selective while investing in midcaps, thereby focusing on visibility of revenues, balance sheet strength, cash flow profile and management quality

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