midcap stocks: Midcaps are where the money is: But you must know certain things about them first

Stocks are classified into three broad categories based on market capitalisation – largecaps, midcaps and smallcaps. Market regulator Sebi has defined the criterion for this classification as follows: largecaps are the top 100 companies by market capitalisation; the next 150 will be midcaps and the rest smallcaps. Largecap companies are the market leaders with mature business models which are generally at peak business cycle phases, and thus they are established entities generating stable revenue and earnings. They tend to move with market economy because of their size. Midcaps, too, are well-established companies, but these businesses are moderately stable with prospects of becoming largecaps as market share, profits, productivity increase. Since the scope of growth for these businesses is higher than that of largecap companies, they have potential to give better returns in a longer time horizon of, say, 3-5 years. With the general elections behind us, the macro-economic conditions of the country appear to have become more stable for the next five years, and the improving business environment has created a conducive atmosphere for midcap companies to grow. Since CY2009, the BSE Sensex has given a CAGR return of 14 per cent while midcaps and smallcaps have given 15 per cent and 13 per cent, respectively. However, during CY2009-17, when Sensex gave a CAGR return of 15 per cent, midcaps and smallcaps outperformed with 21 per cent and 20 per cent, returns, respectively. Since the beginning of 2018 to now, volatility triggered by the liquidity crisis in NBFCs, higher crude oil prices and global trade tensions have led to a sharp price movement in midcaps and smallcaps, which have given a negative CAGR return of -13 per cent and -19 per cent, respectively, while largecap have outperformed with 10 per cent positive return. Despite this, the overall return of midcaps and smallcaps since 2009 has been at par with largecaps. This short-term movement due to the cyclical nature of the stock market has given investors the opportunity to bet on midcaps and smallcaps and earn better returns over a longer period. Returns from the stock market are directly proportional to the risk taken by investors and the duration for which one has stayed invested. Largecaps offer relatively lower returns because of lower risk, owing to the large and stable nature of the businesses. However, as investor’s appetite for risk increases and one moves towards midcaps and smallcaps, the probability of earning higher returns increases. Midcaps offer a moderate risk-reward trade-off and, hence, they are in a sweet spot for mindful investors to earn healthy returns from the stock market. Also, a longer time horizon reduces the risk associated with short-term market fluctuations. It should be noted that macro-economic factors alone are not enough for midcap investing, an investor must try to understand industry trends and fundamentals of companies, in particular, to be able to spot the right opportunity. Midcap companies with sustainable growth opportunities, better execution capability and ability to generate stable cash flows, better return on capital and quality management are the ones that keep floating even when macro-economic uncertainties increase. It is also important to keep optimum diversification while investing in midcaps. An investor can focus on 2-3 sectors that he understands better and have a decent number of diversified stocks within those sectors. Investors can also create their own SIPs (systematic investment plans) whereby instead of investing lumpsum amounts in midcaps, they can stagger investments over time to average the cost of buying, avoid the risk of timing the market and sail through short-term volatility. This approach would help investors reduce risk exposure. However, an investor should also make efforts to keep track of business performance at least on a quarterly basis and have a longer investment horizon, say 3-5 years, for the stock to perform. The GDP of the Indian economy is expected to double from $2.6 trillion at present to $5 trillion over the next 8-10 years, and as the country moves toward this goal, midcap companies would play a crucial role. Investors can ride this growth wave and carefully invest in midcap companies to create wealth as some of these could eventually become largecaps. Do do have this check-list to critically look at corporate governance standards, leadership quality, attractiveness of products, size of market opportunity as well as liquidity of the stock before taking a call on any midcap.

Source: The Times of India

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