The sweet spot in the middle

Some things are always thought of as being 'not something', and what that 'something' is very much determines our opinion. Puzzled by this slightly convoluted statement? Here's an example which every reader of this magazine will understand perfectly. Some think of mid-cap stocks as being 'not large cap' while others as 'not small cap'. Which of the two camps you belong to will decide your approach to mid caps.

If you think of them as 'not large cap', they will supply your portfolio with higher growth potential and possibly better returns than their more established counterparts. You might see mid caps as companies on the cusp of becoming tomorrow's blue chips, offering a sweet spot of stability and growth. Conversely, if you view mid caps as 'not small cap', you might appreciate their relative stability and lower risk than more volatile small caps. They could be a way to diversify your portfolio with companies that have proven business models but still offer room for expansion.

There's nothing wrong with this. It's a cognitive bias that affects many areas of our decision-making! We have to understand it and use it to improve our investment portfolio.

Recognising this bias can help you develop a more balanced strategy in mid caps. Instead of viewing them as simply 'not large cap or small cap', investors should try to appreciate their unique characteristics. These companies often have more agile management than large caps, allowing them to adapt quickly to market changes. Yet, they typically have more robust financials and established market positions than small caps.

This halfway status also extends to choosing mid caps worthy of investing. The agility of business translates to uncertainty in the markets. While this can lead to higher potential returns, it also means that mid caps can be more susceptible to market volatility than large caps. Look for mid caps with strong fundamentals, sustainable competitive advantages, and clear growth strategies. Consider factors like debt, cash flow, and industry trends. The goal is to identify those mid-cap companies that have the potential to become the large caps of tomorrow while managing the risks inherent in their current size and market position.

Still, these potential negatives are less pronounced in mid caps than in small caps. Mid caps often have a more established market presence and financial stability than small caps, providing a buffer against extreme market fluctuations. This makes them attractive, offering a balanced growth potential with a moderate risk profile.

Remember that investing in mid-cap stocks is fundamentally different from investing in large caps. Mid caps often fly under the radar of intense market scrutiny. This means that positive and negative developments can remain hidden for longer periods, potentially leading to sudden price movements when the information comes to light.

Mid caps are also more susceptible to business environment changes, making them more vulnerable to economic downturns. Additionally, a higher proportion of mid-cap companies may face the risk of terminal decline compared to large caps, though this risk is less pronounced than in small caps.

Liquidity is another factor. While mid caps are generally more liquid than small caps, they still don't match the trading volume of large caps. This can lead to more pronounced price movements.

All these factors contribute to making mid-cap investing a different game altogether. And how do you play this game in the best way possible? That's simple: start with the cover story of this issue!

Also read: Mid-cap marvels