ETMarkets Smart Talk| India’s next wealth creators may be hidden in specialised manufacturing and energy infrastructure: Paresh Bhagat

Specialised manufacturing, precision engineering, electronics, power transmission, grid modernisation and renewable energy infrastructure could offer opportunities over the coming decade.

However, identifying these businesses requires more than spotting a promising sector; investors must assess competitive advantages, earnings potential, cash-flow generation and valuations.

In this episode of ETMarkets Smart Talk, Paresh Bhagat, Chairman of Mangal Keshav Financial Services, discusses where India’s next wealth creators could emerge from, why several mid- and smallcap stocks remain priced for strong future growth, and how investors can distinguish expensive growth stories from genuine long-term compounders.

He also explains why valuation discipline matters, whether largecaps are becoming more attractive, and what investors should look for when identifying smaller companies that could grow into tomorrow’s market leaders. Edited Excerpts –

Q) Mid- and smallcap funds have outperformed largecaps over the past year, but valuations appear to favour largecaps. Is this a potential turning point in market leadership?

A) We believe the market may be entering a phase of greater differentiation rather than a complete shift in leadership from midcaps and smallcaps to largecaps. While largecaps currently offer relatively attractive valuations, investors must recognise that today's largecap indices largely represent the established leaders of yesterday's economy. Many emerging businesses benefiting from India's structural transformation are still outside the major indices.

As India's economy evolves, we expect new leaders to emerge from sectors such as specialised manufacturing, electronics, energy infrastructure, healthcare and technology-enabled services. Over time, some of these businesses could grow sufficiently to become important constituents of the Nifty 50 and Nifty 500.

However, identifying tomorrow's leaders does not mean paying any price for them today. Valuations in several midcap and smallcap businesses already reflect optimistic growth assumptions.

We see the current environment as an opportunity to distinguish between expensive growth stories and genuine long-term compounders. We would prefer to wait for more attractive valuations before increasing exposure aggressively.

Q) Are largecaps becoming attractive because their valuations have corrected, or do they also offer better earnings visibility?

A) Largecaps offer a combination of relatively reasonable valuations, greater liquidity and better near-term earnings visibility in several sectors. However, we believe investors should distinguish between earnings visibility and long-term earnings growth potential.

Many established largecap companies operate in mature industries where growth is relatively predictable but may be slower. Meanwhile, certain smaller businesses are operating in industries experiencing structural changes that could support substantially faster earnings growth over the next decade.

The distinction becomes particularly important when we look at global markets. Taiwan and South Korea have benefited significantly from the semiconductor and AI investment cycle, demonstrating how emerging industry leaders can reshape market performance.

India may experience similar transitions across different industries, although the companies and sectors benefiting from them will not necessarily be the same.

We view largecaps as attractive for portfolio stability and selective valuation opportunities, while midcaps and smallcaps remain important for identifying the next generation of industry leaders.

Q) How much future earnings growth of mid- and smallcap companies is already priced in?

A) In several segments, valuations already reflect multiple years of strong earnings growth, creating a situation where companies must deliver consistently to justify their stock prices.

Even when a company delivers strong profit growth, its share price may not generate equally attractive returns if the market gradually assigns it a lower earnings multiple.

Investors may already be paying today for much of the growth expected over the coming years. This is why the price paid matters just as much as the quality of the business.

However, we would not evaluate smaller companies solely through current earnings multiples. Some businesses are entering a phase where new capacities, customer approvals, technological capabilities or expanding addressable markets could materially improve their earnings potential.

Our focus is on understanding whether the company's growth opportunity is structural, whether it has a competitive advantage and whether incremental investments can generate attractive returns.

We are willing to pay a reasonable premium for a business capable of compounding earnings over a decade, but not an excessive premium based merely on an attractive industry narrative.

Q) For an investor starting a fresh SIP today, should largecaps form the core of the portfolio, with mid- and smallcaps playing a complementary role?

A) For investors starting a fresh SIP, we believe largecap or diversified equity funds should form the core of the portfolio, providing relatively greater stability, liquidity and earnings visibility.

Midcap and smallcap funds can complement this allocation by offering exposure to emerging industry leaders and structural growth opportunities, depending on the investor’s risk appetite and investment horizon.

SIPs help average investment costs over time, but do not eliminate valuation risk. Investors should maintain disciplined asset allocation rather than chase recent outperformance.

Q) What could trigger a sustained rotation from mid- and smallcaps towards largecaps?

A) Domestic earnings disappointments, elevated valuations and changes in liquidity could encourage investors to shift towards largecaps.

However, we believe a sustained rotation will become more likely only when foreign institutional selling subsides and the erosion in largecap valuations begins to stabilise.

Foreign institutional investors evaluate India relative to opportunities across global markets. Over the past couple of years, global capital has increasingly gravitated towards leading semiconductor manufacturers and AI infrastructure companies, particularly in Taiwan and South Korea, where earnings momentum has been exceptionally strong.

Consequently, foreign selling in India does not necessarily reflect a negative view of India's long-term fundamentals. It can also reflect the relative attractiveness of competing global investment opportunities.

For a sustained recovery in Indian largecaps, we would look for a meaningful slowdown in FII selling, stabilisation of largecap valuations and improving domestic earnings visibility.

Ultimately, a durable rotation towards largecaps will require foreign selling pressure to ease and confidence to return that the erosion in largecap valuations is coming to an end.

Q) Should investors rebalance towards largecaps after years of mid- and smallcap outperformance, or could that mean exiting too early?

A) We would caution against making investment decisions purely on the basis of market capitalisation. History shows that some of the biggest wealth creators begin as relatively small businesses and eventually become dominant industry leaders.

Exiting such companies merely because they have grown in market value can mean giving up substantial future compounding opportunities.

At the same time, investors should recognise that several smaller companies have experienced significant valuation expansion without a corresponding improvement in earnings.

Our approach is to differentiate between share-price appreciation driven by improving business fundamentals and appreciation driven primarily by market enthusiasm.

Where valuations have become excessive, partial profit booking and portfolio rebalancing may be appropriate. However, where a company continues to strengthen its competitive advantage, expand its addressable market and generate attractive returns on capital, we would prefer to remain invested.

We would rather own tomorrow's largecap leaders while they are still small than rotate indiscriminately into today's largecaps simply because they appear relatively cheaper.

Q) How do you identify companies that can graduate from smallcap to midcap and eventually become largecap leaders?

A) We look for companies operating in industries where the underlying market opportunity can expand significantly over the next five to ten years. The first requirement is a structural growth opportunity.

This could arise from import substitution, technological change, manufacturing localisation, rising formalisation or increasing demand for specialised products and services. The second requirement is a durable competitive advantage.

We look for evidence such as customer approvals, technological capabilities, high switching costs, strong distribution networks, consistent product quality and increasing customer relationships. The third requirement is the ability to scale profitably.

Many companies can grow revenues rapidly, but far fewer can maintain healthy returns on capital while expanding. We particularly like businesses where incremental revenue requires proportionately less incremental capital over time, allowing operating leverage and free cash flow to improve. We also evaluate management's capital allocation decisions and historical execution record.

The strongest indication of a future industry leader is not simply rapid growth, but the ability to become more competitive, more profitable and financially stronger as the business scales.

Q) Where could India's next generation of small- and midcap wealth creators emerge from?

A) We believe India's next generation of wealth creators will emerge from businesses participating in structural changes across the economy. Specialised manufacturing, precision engineering, electronics, industrial automation and import substitution remain particularly interesting areas.

India's increasing focus on domestic manufacturing and supply-chain diversification creates opportunities for companies with genuine technological and execution capabilities.

Power transmission, grid modernisation, renewable energy integration and energy storage could create opportunities across specialised equipment and component manufacturing. We also see potential in healthcare, diagnostics, pharmaceutical outsourcing, financial infrastructure and technology-enabled services.

However, an important lesson from the global semiconductor and AI cycle is that the biggest beneficiaries of a megatrend are not always the most visible companies selling the final product.

Significant value can also be created by businesses supplying critical components, specialised materials, equipment and enabling technologies. We therefore focus on identifying companies positioned at important points in an industry's value chain, particularly where capabilities are difficult to replicate and competition is limited.

Our objective is to identify businesses that can become indispensable participants in a growing industry, rather than simply investing in whichever sector is currently attracting the most attention.

Q) How important are return on capital, cash-flow generation and balance-sheet strength? Which financial warning signs would make you avoid a stock despite its growth potential?

A) These are among the most important factors in our investment process.

Revenue growth tells us how quickly a company is expanding, but return on capital tells us whether that growth is creating economic value.

We prefer businesses capable of generating returns on incremental capital above their cost of capital, supported by strong cash-flow conversion and prudent balance-sheet management.

One of the biggest warning signs is a company reporting consistently rising profits while operating cash flow remains weak. This can indicate excessive receivables, inventory accumulation or aggressive revenue recognition.

Other concerns include rising debt without a corresponding improvement in profitability, repeated equity dilution, frequent related-party transactions, aggressive acquisitions and capital expenditure that fails to generate adequate returns.

We also closely examine whether management's historical execution matches its earlier guidance.

A company may operate in an attractive industry and report impressive revenue growth, but if that growth continuously consumes capital without generating cash, shareholder returns can remain disappointing. For us, the quality of earnings is just as important as the rate of earnings growth.

Q) Small-cap funds attracted ₹9,039 crore, while mid-cap funds received ₹7,835 crore. Given the strong investor interest, are valuations justified by earnings growth?

A) The strong inflows demonstrate the increasing participation of domestic investors and their confidence in India's long-term growth potential. However, fund flows and earnings growth are two different things.

Liquidity can support valuations for extended periods, particularly in relatively less liquid smallcap and midcap stocks. But over the long term, shareholder returns must be supported by actual earnings growth, cash-flow generation and returns on capital.

We believe valuations in several pockets of the broader market have already discounted substantial future growth. In our view, markets remain priced to perfection.

We have consistently emphasised the need for valuation discipline over the past year, particularly where share prices have moved ahead of underlying fundamentals.

At the same time, India is undergoing structural changes that could produce an entirely

new generation of market leaders over the coming decade. Therefore, we remain constructive on the long-term opportunity but cautious about near-term valuations.

Our preference is to maintain investment discipline, wait for further corrections and selectively accumulate high-quality businesses benefiting from structural megatrends.

We would rather miss a short-term rally than compromise on valuation discipline. Ultimately, the biggest wealth creation opportunities will come from identifying tomorrow's industry leaders early and allowing their earnings to compound over time, rather than chasing stocks simply because liquidity is flowing into the segment.

We believe the coming months could present an important opportunity for long-term investors. While near-term volatility and further valuation corrections cannot be ruled out, India’s structural growth opportunities remain intact.

Our expectation is that Q4 FY27, the January–March 2027 quarter, could be one of the last major windows for investors to accumulate high-quality businesses at reasonable valuations before the next phase of market recovery.

This is a forward-looking assessment, and its timing will depend on earnings delivery, foreign investor flows and global market conditions.

We would therefore prefer to remain patient, preserve liquidity and prepare to deploy capital selectively into businesses with strong competitive advantages, healthy balance sheets and sustainable long-term earnings potential.