This article talks about mid-cap stocks, their features, benefits, and the risk associated with them.
Mid-Cap is a term used for companies and stocks that falls between small-cap and large-cap categories. The classification of companies into mid-cap is based on the company’s ranking in the benchmark indices on the basis of market capitalization. In India, companies that are listed and ranked between 101-250 in the Nifty Index are considered mid-cap companies. The market capitalization of mid-cap companies generally ranges between 5,000-20,000 crores. The classification of companies based on market caps is variable as it changes with changes in a company’s market valuation. Mid-Cap stocks have the potential to put investors in an advantageous position through risk moderation and substantial returns. They also help investors to diversify their risk and portfolio. Nifty has a benchmark mid-cap index in India which is known as Nifty Midcap 50. This index hosts the top 50 most traded mid-cap securities on the stock market.
Features of Mid-Cap Stocks
- High growth potential: Mid-cap stocks are offered by medium-sized companies. These companies are yet to realize their full potential. They have huge potential to grow further in the long run and thus can give high returns on initial investments.
- Moderate to High Risk: When we compare mid-cap stocks with small-cap stocks, we can say mid-cap stocks are more stable, less volatile, and thus less risky. But overall, mid-cap companies still have a higher risk element. Mid-cap stocks offer high returns and thus are accompanied by higher risk.
- Liquidity: Mid-cap companies are generally well-known among investors and thus it is relatively liquid as compared to small-cap stocks. It is easier to find buyers as and when required while trading mid-cap stocks.
- Returns: Mid-cap stocks have the potential to deliver strikingly high rates of return on investments. They are known to beat inflation in the long run.
Benefits of Mid-Cap stocks
- Diversification of Risk: Investors look at mid-cap stocks to diversify their risk. Small-cap stocks offer high growth potential but come with the greatest risk, while large-cap stocks offer stability, but give lower growth prospects. Mid-cap stocks represent a fusion of the two and thus provide a balance between growth and stability.
- Inflation-beating Returns: Mid-cap companies in India have a high potential to enhance their performance and market share. These companies have a history of performing well during the market expansion phase. Over the years, mid-cap stocks were able to produce inflation-beating returns.
- Hidden Opportunities: Mid-cap stocks are underfollowed in stock markets giving huge potential to investors to uncover hidden opportunities. Mid-cap companies are not adequately analyzed in their initial days and get only limited attention from large and institutional investors. Through research and analysis, investors need to identify stocks that can give substantial returns in the future.
- Growth: Mid-cap companies are a better place than small-cap companies when it comes to raising finance through credit. Thus, mid-cap companies have greater potential for growth and expansion. As mid-caps are less risky than small-cap companies, they manage to do relatively well during times of economic turmoil.
- Less Risk-Averse Investors: Since mid-cap stocks are riskier than large-cap stocks, they tend to give higher returns. This feature of mid-cap stocks specifically appeals more to less risk-averse investors.
Risk Associated with Mid-Cap Stocks
A few dangers related to investing in mid-cap stocks are:
- Value Trap: A value Trap is a situation where a company consistently operates at low profits and with limited cash flows. Mid-cap organizations, particularly the low positioning ones are inclined to worth trap and may go defunct if this pattern continues for a longer period.
- Hard to benchmark: This problem is specific to mid and small-cap stocks. Mid-caps are so diverse in nature that it becomes hard to club them under a single category and to create an index out of it. Even if the index is created it can not be viewed as a benchmark index as it only represents a bunch of companies trading in a similar market cap range.
- Insufficient Assets: Due to its size, mid-cap companies are probably going to have less proficient managerial, administrative, and organizational infrastructure as compared to large-cap companies. Thus, even though mid-cap companies may have huge upside potential, but they might not be equipped to work at their full potential.
- Market Bubble: During market bubbles or balloons, mid-cap companies may display extraordinary performances. These companies may not even have the financial strength to survive after the bubble explodes. Therefore, it is of most importance that investors check the financial history of mid-cap companies before such a bubble to ensure the financial strength of the company.
How to monitor Mid-Cap Stocks
Investors should monitor mid-cap stocks closely before investing in them due to various risks associated with them. This requires a close analysis of the following:
- Performance over the last 4-5 years: To determine the financial stability and strength of the mid-cap companies, it is important to monitor the mid-cap stock’s performance over the last 4-5 years. It is prudent to invest in stocks of only those companies that have delivered consistently over the period.
- Check on the Macros: It is vital for investors to keep an eye on company-specific as well as industry-specific macros on a regular basis. For instance, non-banking financial companies are subject to interest rate and Non-Performing Assets susceptibilities. These factors play a key role in the overall performance of mid-cap stocks.