These mid-caps look expensive, yet give good returns. Should you invest?

The mid-cap space is turning out to be an expensive affair. In fact, many mid-cap stocks are trading at a higher valuation multiple than the index itself.Dixon Technologies, a homegrown manufacturer of consumer durables, home appliances and mobile phones, is one such stock. It has a price-earnings (PE) multiple of 182x. Over the past year, the stock has given a 151% return. Many analysts believe that the shares deserve this valuation, as the company is going to almost double its revenues in the next three years.Dixon is not the only stock that is expensive. The entire mid-cap space is expensive — advisers and analysts have been telling us this for more than a year. Sample this: the Nifty Midcap 150 index trades at a PE multiple of 45x, compared to 28x for the Nifty 50 and 30x for the Nifty Smallcap index.However, there are many experts who feel that the mid-cap space deserves this valuation because many of these stocks are growing at a faster pace. Many believe that Dixon is a great buy because the PE multiple might be high but then the business growth is strong. The other view is that any stock above a PE of 100x rarely makes money. And that is what most advisers believe.For example, in June 2023, Elara Capital released a report advising its clients to ‘reduce’ their exposure to Dixon. “We lower our EPS (earning per share) by 7% for FY24E and 6% for FY25E on the likely impact of a global slowdown in the consumer electronics businesses. We revise to reduce from accumulate,” the report said. Interestingly, the stock has been up 13% since then.However, Elara Capital expects Dixon’s earnings CAGR (compound annual growth rate) at 50% over FY23-25E with an RoE (return on equity) of 27%, propped by the PLI (production-linked incentive) scheme for electronic products; the rising demand for the outsourcing model, especially from large MNCs in the durables industry; export opportunities (low-cost producer); and operating leverage, which may bolster margin.So, should you buy Dixon, or for that matter any mid-cap stock, at such a high valuation? medium nocaptionhttps://youtu.be/BOZqCzd3FgY?si=XmozlX140CqtYZegLessons from the pastThere are many mid-cap companies that are trading at a PE of more than 100x.When a company trades at a PE multiple that high, there is a general feeling that the company is going to grow its earnings 2x in a year. It happened during the software boom of 2000, when stocks like Wipro and Infosys got PE multiples of more than 100x. Some analysts felt that these stocks deserve that kind of valuation because these companies were operating in a pool where the demand was much stronger than supply.Eventually, these companies fell from their top and it took them years to come back to the same price. In March 1999, the price of Wipro was ₹27 per share which rose to ₹172 in March 2000 and came down to ₹31 in April 2001. It took the company 13 years (September 2013) to touch the same price of ₹172.Back then, everyone said that Wipro and all other software stocks were expensive. But analysts, and even fund managers, were wrong in their assumption. It had nothing to do with the company but could be attributed to the greed of the market. In fact, many times in the past, software companies had gone to brokerage houses to tell them that their companies did not deserve high valuations. However, some fund managers felt that these companies did not understand their own markets and demand.Today, we are in a similar market, especially in the mid-cap space, where some companies are getting valued at a PE above 100x.Some investors want to be cautious with these expensive stocks. However, there are others who say that these companies deserve the valuation and argue that the market is growing at a faster rate, so a high PE is not a worry.We agree that PE multiples should not be seen in isolation. One needs to look at many aspects when evaluating a company. But most importantly, we need to look at the past and ask ourselves if we should buy high PE stocks, especially in the mid-cap space.The high PE stocksET Prime looked at 20 top companies in the Nifty Midcap 150 index that were trading at a higher PE multiple than the index itself. These stocks were also filtered based on RoCE (return on capital employed), PAT (profit after tax) growth and sales growth to weed off stagnant loss-making companies. Below are our findings. medium1130847141. Dixon trades at a PE multiple that is the highest on our list and in the sector. This is because it has the highest PAT growth, and RoCE and sales growth in the sector. Though not an exact apple-to-apple comparison, Blue Star has the same RoCE and sales growth as Dixon in the consumer durables space, but it has not been able to report profits to the tune of Dixon.As per a report by BNP Paribas, Dixon has been a major beneficiary of the PLI scheme. Over the past decade, Dixon’s product mix has shifted towards the high-volume mobile phone segment (62% of FY24 sales) from the consumer electronics (TVs) segment (60% of FY13 sales).Mutual funds have been steadily increasing their stake in the company for the past year from 13% in June 2023 to 18% in June 2024.2. Kalyan Jewellers is trading at a PE multiple of more than 100x. This is slightly higher than the market leader Titan, which trades at a PE of 92x. But again, Titan has given a consistent RoCE of more than 20% in the past couple of years.“We remain upbeat on Titan’s operating performance led by strong demand across business segments. Its footing in the international market appears to be promising. Risks are irrational competition from regional players; prolonged recovery in the economy leading to lower demand and rising gold prices,” stated a recent Centrum Broking report.Kalyan Jewellers has moved up 174% annually in the past two years while Titan delivered 17% returns during the same time.3. BSE is the only stock on our list where retail investors are the majority shareholders. The stock is trading at a PE of 64x and has given close to 200% returns in the past year. The exchange has reported high profit growth and sales growth for the year.Mutual funds have been buying this stock for the past year. Discount brokerage firm Zerodha reduced its stake in BSE from 23.3 lakh shares (1.72%) in the March quarter to 19.8 lakh (1.46%) in the June quarter.“The relaunch of BSE derivatives products has proved to be a trend-changing measure. The momentum for stock futures and options (F&O) launched in July is still at a nascent stage. Considering the uncertainty on the eventual F&O regulations that are likely to be announced, we have maintained our ‘neutral’ rating on the stock,” states a recent Motilal Oswal report.4. Gujarat Fluorochemicals shot up in April 2021 and has remained flat for the past year at just 4%. However, the stock trades at a PE of more than 100x. Promoters reduced stake in the company in June from 63.81x to 62.58x.“FY25 outlook, too, remains subdued on flattish guidance for the bulk and fluorochemicals businesses year-on-year. Though the fluoropolymers business is recovering, contribution from battery chemicals is still some time away. We believe possible ramp-up in the battery chemicals business has already been factored into the CMP (current market price). We cut FY25E/26E earnings by 10%/9% to factor in the sluggish fluorochemicals business outlook,” states a May Emkay report.5. UNO Minda is another company where promoters have drastically reduced their stake from 70% to 68.75% in a year.The final cutSo, what should investors do?There is a strong chance that some of these stocks are going to end up like Wipro in 2001. Even if we assume that some of these companies have strong growth potentials, the valuations are expensive.Mid-cap stocks are best approached through a value-investment framework. If valuations are high, ask as many questions as possible.Stocks above the PE of 100x generally are fully valued by the market. If you still want to invest in these stocks, you may have to wait for long and the opportunity cost will be high.