10 Important Facts About Indian Mid-Cap Stocks

Mid-cap stocks are shares of companies with a total market capitalisation of more than Rs 50 billion but less than Rs 200 billion.

Betting on them is perceived to be risky. However, the potential for higher returns makes them an appealing investment avenue.

While there is nothing wrong with aiming for higher returns, it is necessary to understand them well. Especially, the kind of risks that tag along with the outsized returns.

Keeping this in mind, we highlight ten important facts about Indian mid-cap stocks.

#1 The promise Of High Prospective Returns

We all understand the draw towards mid-cap stocks. The prospect of potentially life-changing returns makes them an attractive avenue for all.

The relatively small size of their business means they enjoy plenty of room for growth. They can multiply faster and can grow your money exponentially.

Take HDFC Bank, for example. In 1995, the company was listed on the stock exchange. It traded as a smallcap until 2000 and went on to become a midcap from 2000 to 2006. Bajaj Finance was categorised as a midcap stock until 2015.

Back in the day, it was easier for the financial giants to double their sales in a short span. But now, due to their sheer size, it will be tough to achieve the same.

As attractive as these outsized returns seem, they don't come smoothly. Companies can sometimes take years to generate strong returns. This brings us to our next point.

#2 The High Level Of Returns Don't Come Smoothly

The outsized returns in midcap companies don't always follow a smooth path. They usually take time and tend to be volatile.

These traits require you to be patient and more accepting of the swings that come with the massive returns. Come to think of it, the outsized returns are compensation for assuming that extra bit of risk.

Large-cap stocks offer relatively lower returns but carry lower risks as well. The stock prices don't swing as much as their smaller counterparts.

Smallcap stocks score high on the volatility scale while largecap stocks lie at the lower end.

Midcap stocks are somewhere in the middle. While you may earn a 15 per cent return in a stable large-cap stock like ITC, you may earn a lot more in a volatile midcap like Balkrishna Industries.

Besides investing in mid-cap stocks is a great way to access niche growth stories.

#3 Want To Invest In India's Largest Power Trading Platform That Is A Market Leader? You Got It!

There are several companies that operate in tiny or niche industries. These companies never become large corporations, but this doesn't make them any less exciting.

Not only are these new and exciting, but such companies offer a better mix of themes for your portfolio holdings.

Look at Indian Energy Exchange, for instance. This unique company is India's first and biggest power trading platform. The company enjoys a monopoly with a staggering 97 per cent market share of the volumes traded on the power exchange.

This stock is not a recommendation but a example of a high-potential midcap.

But sometimes, these niche stories need time to reach their full potential.

#4 Midcap Stocks Sometimes Take Time To Realise Their Potential, Testing Your Patience.

In comparison to largecap stocks, mid-cap stocks are relatively new businesses. These companies are usually in the early stages of a business cycle and can take a little longer to realise their full potential.

And the worst part is that no one can predict that timeline for you.

While all this makes it challenging to hold on to the stock, it can be worth the wait.

Think about it. What if Ramesh Damani had sold his holdings in Infosys? He bought it in 1993. The stock went up 100x by 1999.

So, apart from keeping calm, you must understand that a long investment horizon means your money is stuck for longer. Therefore, only invest your surplus funds in mid-cap stocks. Money that you will not need in the short term.

Moreover, midcap stocks tend to outperform the best companies in a bull market. They can generate outsized returns in a short period.

But why do they outperform large caps in bull markets?

Let's look into it.

#5 Midcaps Can Grow Faster Than Largecaps In Bull Markets  

History tells us that midcaps often outperform largecaps in bull markets.

The primary reason is the size of the companies.

Midcap companies are smaller than their larger counterparts (largecaps). Their size makes them more agile, giving them more room for growth. So, if these businesses can grab great opportunities at the right time, they can get on the fast track to growth.

Eventually, if the business does well, a midcap can quickly grow into a largecap stock. The big guns of today like HDFC Bank, Tata Consultancy Services, and Larsen & Toubro, were all midcaps a few years ago.

But as well as midcaps perform in bull markets; they have a long history of underperformance during market meltdowns.

Let's understand this better.

#6 Midcaps Are More At Risk In Bear Markets

Midcaps are more at-risk during market downturns. This was apparent in the early months of the pandemic.

During the first few months of the economic crisis, the midcap stocks underperformed their largecap peers by a significant margin.

But why do you ask?

It's basic human nature. Under any uncertainty, human beings want to safeguard their money. More so when it's their hard-earned savings.

You don't want that money floundering around in new businesses. They don't enjoy the same resources as large corporations with a long history of operations.

Furthermore, you want to be able to liquidate your holdings faster.

Therefore, during any economic crisis, investors dump their smaller albeit highly volatile stocks first, i.e., midcaps. They all leave them behind, flocking over to the well-established and liquid companies, i.e., largecaps.

#7 Midcaps Usually Enjoy A Strong Financial Footing Compared To Their Smaller Peers, i.e. Smallcaps

Midcaps are smack in the middle of the capitalisation ladder. They are sandwiched between largecaps and smallcaps. Therefore, they share the characteristics of both, albeit at different degrees.

While largecaps are more financially sound than midcaps, smallcaps fall short on this measure. They are a lot more unstable financially when compared to their larger peers, the midcaps.

Think about it. The underlying business is a lot more established than smallcaps. This allows the midcaps to take on any headwinds that may come their way.

#8 The Large Buyers In The Investing World Quite Fond Of Midcap Stocks

Large institutional investors, domestic and international, are always on the prowl for good investments. Moreso on the lower end of the capitalisation ladder. While they avoid smallcaps due to their less liquid nature, they like midcpas.

So, your job is to discover such high potential midcap before they come under the institutional radar. A classic example is of Balkrishna Industries and Page Industries. These two stocks were midcaps for a long time but soared after fund managers spotted them.

The sudden focus of large investors on certain mid-cap stocks can make a huge difference to their valuations. This brings us to our next point.

#9 Some Of The Best Bid-cap Stocks Always Carry The Potential For Re-Rating

Much like their smaller peers, mid-cap stocks are also like undiscovered gold. Think of Bajaj Finance in 2015 or Jubilant Foodworks in 2010.

Their obscurity implies that they are available at a bargain. But this also means you can be one of the first investors in the company. It will be like catching MRF at Rs 6,000 in 2010 (now trading at Rs 89,000) or Page Industries at Rs 4,000 in 2013 (now trading at Rs 49,000).

Much before these stocks were re-rated and their prices shot up.

Usually, when these stocks hit the lime light they are re-rated. Their valuations and prices go through the roof. And this usually happens when they come under the institutional investor's radar.

But this doesn't mean all mid-cap stocks will help you create a small fortune. So, when it comes to these volatile investments, you must tread with caution.

#10 While Investing In Midcaps, Be Highly Selective And Choose Wisely

Midcaps have a long history of robust returns. But that doesn't mean all midcaps are worth investing in.

Some are good, while others are not.

So as an investor looking to profit from midcaps, be very careful.

Midcap stocks usually derive value from their growth potential and sometimes the growth potential doesn't come through. This can lead to massive value erosion.

Therefore, act wisely while picking out investments in the midcap space.

Look for financial strength, economic moats in the business, leadership in the market and strong management skills etc.

The safer, the better.

In Conclusion

Midcap stocks carry greater risk than the stocks of largecaps. But with the right stock selection skills and investing temperament, they are worth every bit.

The attractive upside potential in bull markets that can help you create a tiny fortune makes them worth all the risk.

Imagine spotting the next Titan or HDFC Bank. Not only will it make up for the other losers in your portfolio, but it will also multiply your wealth beyond your imagination.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com.

(Except for the headline, this story has not been edited by NDTV staff and is published from a syndicated feed.)