Popularity of mid-cap stocks has risen over the last 1 year and the mid-cap indices reached all-time high levels this month. Now, as valuations for this segment seem to have risen too fast, experts are suggesting caution. Here's why mid-caps are considered riskier than large-caps and what mid-cap investors should be careful about.
Research and information
If you consider the BSE Mid Cap index, its smallest stock has a market capitalisation (market cap) of around Rs.2,600 crore and the largest is around Rs.55,000 crore. For the CNX Midcap index, this range is between Rs.2,800 crore and Rs.94,000 crore. Thus, the definition of mid-cap varies, but what we know is that these companies fall between the large- and small-cap segments. Even though they are not large in terms of revenue and market cap, they can be market leaders. Given the wide market cap range that defines this category, many listed companies fall under it. And due to the large number of such companies, research analysts aren't able to track all of them thoroughly. For example, while 18 analysts track Glenmark Pharmaceuticals, according to Bloomberg, only two track Piramal Enterprises. Therefore, due to lack of information, their price reaction to news and corporate actions can be sharp. Large-caps are better covered, hence a lot of the news about them gets priced into the stock's value well in advance.
Liquidity and price impact
Liquidity is the extent to which you can buy and sell a stock without impacting its market price. This is a function of the number of shares available and traded daily. While liquidity may not be a concern for mid-cap stocks with larger number of shares available, in some cases daily liquidity can be low. For example, Bajaj Holdings Ltd is a mid-cap stock with a free float market cap of around Rs.10,600 crore. Its combined traded quantity on BSE and NSE on Tuesday, 16 August, was 31,000 shares (compared to a 2-week average daily trading quantity of around 24,000 shares). Compare this to Emami Ltd's free float market cap of around Rs.7,300 crore, which traded 160,000 shares on the same day compared to its daily average of around 130,000. When trading quantity is low, large orders of buying and selling can have a big impact on the stock's price. If the daily trading quantity is high then large trades can go through without impacting the price a lot.
Management and corporate governance
Once again it comes down to analyst coverage. The financial numbers of companies are published and analysed. But their corporate governance and management quality also need to be scrutinised. Better analyst coverage is important for ascertaining the quality of management.
For individual investors looking to benefit from a mid-cap rally, stock selection is key. In the long run, data shows, good-quality mid-cap companies-despite short-term price volatility-are able to outperform large-caps. At the other end of the spectrum, where quality of information available is minimal, mid-cap stocks have been known to become penny stocks too. Therefore, other than the risk of short-term price volatility, stock selection is the big risk with mid-cap companies.
In arrangement with HT Syndication | MINT
This article was originally published on August 22, 2016.
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