Beginning of revival right time to invest in mid-caps
Anticipating an economic revival with the new government, the Indian stock market is expected to perform better in the coming years. Historical data suggest that when markets bounce back, mid-cap and small-cap indices rise faster than the overall market.
Mid-cap is an abbreviation for the term ‘middle capitalization’. Market Capitalization is calculated by multiplying the number of company’s outstanding shares by its current share price. Based on this, a stock is categorized as large, mid or small cap. The exact definition of these terms can vary among various participants in the equity market. Generally, stocks with an average free float market capitalization ranging from Rs 1,000 crore to Rs 5000 crore are classified as mid-cap stocks. Over the long term, mid-cap stocks have the potential to outperform broader the market and offer more attractive risk returns characteristics.
Why you should invest in mid-caps:
Here, small-cap growth is combined with large-cap stability, and thus mid-caps shares provide investors with the best of both worlds. Progressed through the small-cap status, mid-cap companies may have proven business plans and a more experienced management. Also, smaller in size, midcaps have high growth potential compared to the large-caps. Most of the time, stocks with smaller market caps are usually undervalued, since their potential is yet to be discovered. Investors can reap the benefit by investing in such stocks if they can identify the stocks which have the potential to become tomorrow’s large-caps. The mid-cap segment of the stock market is, thus, being increasingly perceived as an attractive investment segment with high growth potential. Investors should have great patience while investing in midcap stock because the actual growth in such stocks can be expected only in the long run.
Risk associated with midcap stocks:
Mid-cap stocks, which normally have the potential to grow faster than large-cap stocks, come with some extra risks. High volatility is normally associated with mid-cap stocks. During a slowdown in the economy, small-cap and midcap companies suffer the most due to low margins and poor profitability that reflect in their prices. In the last few years, when stock markets faced a lot of uncertainty starting with the global financial crisis of 2008, mid-cap and small-cap categories underperformed the broader market. Investors who have a high risk-high return profile and long investment horizon should only invest in mid-cap stocks. Moreover, exposure to mid-cap stocks should be limited to 30-40 % of the total equity portfolio. Also people with an investment horizon below five years should avoid mid-cap stocks in their portfolio.
Identify the right mid-cap stock:
Mid-caps are under-researched and hence analyzing financial health is very important when selecting a mid-cap stock. According to Benjamin Graham, three criteria are important to assess the financial health of a company: Total debt that is less than tangible book value, a current ratio greater than two and total debt less than two times net current asset value. In addition to earnings growth, it is important to find stocks whose earnings are sustainable for many years to come. That’s what turns a midcap into a large-cap. It is important to invest in companies with strong balance sheet. Stocks with high dividend yield, low price to book ratio and low price to earnings ratio have potential to deliver higher returns.
Take the mutual fund route:
Mid-cap companies typically receive less analyst coverage than large cap companies and, therefore, it is more important for investors to take help of professionals to pick the right mid-cap stocks. Investors who have expertise, access to research and time to track these stocks can invest directly. However, for an investor with limited knowledge of the equity market, it is better to choose the mutual fund route. Accessing mid-caps through actively managed mutual funds may offer investors the opportunity to leverage the benefits of mid-cap stocks.
