Mid-cap stocks are stocks of companies that belong to the mid-cap capitalisation category. According to SEBI categorisation, companies with a market cap above Rs. 5,000 cr but less than Rs. 20,000 cr qualify as mid-cap companies. Let us delve into the concept and look at the advantages and risks of investing in mid-cap stocks.

This article covers:

What are mid-cap stocks?

The word ‘mid-cap’ refers to companies and stocks that sit between the large-cap and small-cap categories. Mid-caps are companies with a market capitalisation of more than Rs. 5,000 but less than Rs. 20,000 cr. Market capitalisation in simple terms refers to the aggregate market value of the company, which is obtained by multiplying its outstanding shares with the current stock price.

As companies’ market value increases or decreases through time, the capitalisation category they belong to also shifts in line. 

SEBI (Securities Exchange Board of India) further defines the classification according to a company’s position in benchmark indices. Enterprises that are listed between 101st and 250th on the Nifty Index are termed mid-cap companies. The Nifty Midcap 50 is a benchmark mid-cap index that includes the top 50 most actively traded mid-cap equities in India.

Factors to consider before investing in mid-cap stocks

Growth

The two most essential drivers in long-term returns are revenue and earnings growth. Revenue growth is an important aspect, but so is operational growth. Because of their greater growth potential on both the top and bottom lines, stocks of mid-cap companies, more often than not, exhibit better performance than large-cap and small-cap firms. 

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Mid-cap stocks are generally quick to respond to economical/ financial events than large caps and are more financially solid than small caps, giving them the edge for yielding good returns.

Management quality

When investing in mid-cap stocks, it is paramount to consider the management quality and efficiency. The bonus may be on investors to ensure that management has the skill and bandwidth to take the business to the next level. Due to the under-researched nature of mid-cap companies (by brokerages and research firms), stricter due diligence may be required.

Competitive advantage

One of the easiest methods to spot a solid mid-cap stock is to look for a competitive advantage. As the business grows, it may stay competitive by providing better services and goods. Competitive advantage can come in the form of a better product or a lower price. 

It is also crucial to have a price edge. A price setter frequently receives the first-mover advantage, allowing it to lead the rise while the rest of the market follows. It is preferable to follow the pack leader rather than a laggard.

High margin

Another criterion for picking strong mid-cap companies is to look for ones with high margins. Companies may command high margins due to a lack of competition or having a moat, better operational efficiency, or because they have a dominant position in the industry. Watch for such strong fundamentals before investing in mid-cap stocks.

Risks of investing in mid-cap stocks

Around market peaks, mid-cap stocks and funds can be pretty volatile. There is a high possibility that mid-cap companies are either unduly reliant on a single line of business or are overly reliant on a small number of clients. With regard to stock price, given the relatively smaller market capitalisation compared with large-cap companies, the stocks tend to react quickly to market events.

Primary risks to consider while investing in mid-cap stocks:

Volatility: Mid-caps are extremely sensitive to any market movements or events. They are high beta stocks and thus have an inherent risk of being volatile. When market valuations are soaring and markets are volatile, mid-caps tend to be more prone to price shocks. Mid-cap stocks are generally more volatile than large-cap stocks. 

Liquidity: Liquidity refers to the ease of buying or selling an investment quickly. Mid-cap stocks tend to have less liquidity as the demand for their stocks may be limited than larger-cap stocks. 

Lack of resilience: Mid-caps have limited resources at their disposal. Their infrastructure and management may not be comparable to that of large caps. Furthermore, any significant economic change or financial bubble can leave the company struggling to sustain itself.

Conclusion

Midcap stocks are of companies that command a market cap between Rs. 5,000 to Rs. 20,000 cr. While the potential for capital appreciation is higher in mid-cap stocks compared with large-cap stocks, the risk is also higher in line. A little amount of exposure to mid-cap equities is, however, required for a well-balanced portfolio. Before investing in a mid-cap stock, do your homework on the firm and only invest if you can digest market fluctuations.

Manonmayi

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