Start investing with a longer horizon in mid-cap stocks now

The views and opinions expressed are of Mr. Arun Thukral, MD & CEO, Axis Securities.

As we all know, stocks are classified into large-cap, mid-cap, and small-cap based on their market capitalization. Market regulator SEBI has defined the criterion to categorize a company as large-cap, small-cap or mid-cap. Large-cap companies are the top 100 companies by market capitalization while midcaps are the next 150 companies. Rest all the companies fall under small caps. Large-cap companies are the market leaders with mature business model generally at peak business cycle phases, generating established and stable revenue and earnings. They tend to move with the market economy because of their size. Mid-caps are well-established companies but business is moderately stable with prospects of becoming large cap as the market share, profits, productivity, etc. of the company increases. Since the scope for growth is higher than large-cap companies, the potential to give better returns is high over 3-5 years of time horizon. With general elections behind us, the macro-economic conditions in the country appear to have become more stable for the next 5 years; improving the domestic business environment in the country has set the conducive atmosphere for mid-cap companies to grow.

During the period of CY2009-present BSE Sensex has given a CAGR return of 14% while mid cap and the small cap has given 15% and 13% respectively. However, if we look at the return for the period of CY2009-17, Sensex has given a CAGR return of 15% while mid and small cap outperformed with 21% and 20% respectively. Since the beginning of 2018 to present, volatility triggered by NBFC liquidity crisis, higher crude oil prices, global trade tensions have led sharp price movement within the mid and small cap that has given a negative CAGR return of -13% and -19% respectively while large-cap outperformed with 10% positive return. Despite this, the overall return of mid and small cap during 2009-present has been at par with the large cap.  This short term movement due to the cyclical nature of the stock market has given investors the opportunity to enter mid and small cap and earn better return over a longer period. The stock market return is directly proportional to risk taken by investors and the duration for which one can stay invested. Large caps offer relatively lower return because of lower risk owing to the large and stable nature of the business. However, as an investor’s appetite for risk increases and he moves towards mid and small cap investing, the probability of earning higher return increases. Mid-cap offers a moderate risk-reward trade-off and hence are at 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 fluctuations.

It should be noted that macro-economic factors alone are not enough for mid-cap investing, an investor must try to understand the industry trend and fundamentals of the companies in particular to find the right opportunity. Mid-cap companies with sustainable growth opportunities, better execution, ability to generate stable cash flows, better return on capital and quality management are the ones that keep floating even when macro-economic uncertainties increases. It is also important to keep optimum diversification while investing in mid-cap. An investor can focus on 2-3 sectors that he understands better and within those sectors, have a decent amount of diversified stocks. Investors can create their own SIP (Systematic investment plan) where rather than investing a lump sum in these mid-caps, he can opt to stagger his investments over a period of time to average his cost of buying, avoid the risk of timing the market and sail over short term volatility. This approach would help investors to reduce their 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 current USD 2.6 trillion to USD 5 trillion over the next 8-10 years and as the country progresses toward it, mid-cap companies would play a crucial role. Investors have the opportunity to ride this growth wave and carefully invest in mid-cap companies to create wealth as these mid-cap becomes large-cap companies. (Flag off few concerns like corporate governance, illiquidity, etc and positives like a leadership position, product basket, opportunity size, etc for midcaps). 

Originally published in ET Market Moguls, Sep,19.