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Mid-caps: Is there a reason? - Views on News from Equitymaster
 
 
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  • May 18, 2005

    Mid-caps: Is there a reason?

    Yesterday marked the anniversary of the dreadful 'Black Monday' of last year (May 17, 2004) when the Indian markets witnessed their worst fall in history. The severity of the fall on that ill-fated day could be gauged from the fact that trading on the bourses was suspended twice within the first 90 minutes of trade as the indices 'comfortably' breached the 15% levels, in-turn triggering the circuit filters. However, while the 'traders' would have certainly got caught on the wrong foot on that day, 'patient investors' who took advantage of this market irrationality to build their portfolio, or at least just held on to the same, must be laughing their way to the bank.

    This is because, since then, while index stocks have given handsome returns, mid-cap stocks have been on fire (see tables below). And this is what has been reflected in the respective indices. As can be seen in the charts above, while the NSE-Nifty has gained 43% in the last one-year, the CNX Mid-cap 200 has gained a whopping 110% in the same period! It must be noted here that while the benchmark indices have still some way to breach their all-time highs again, the CNX Mid-cap 200 index recently achieved new record highs.

    Key gainers over the year (NSE-50)
    Company Price on
    May 17, 2004
    Price on
    May 17, 2005
    Change
    NSE NIFTY-50 1,389 1,991 43.4%
    L&T 453 1,026 126.5%
    BHEL 397 861 117.0%
    SCI 69 150 115.7%
    SAIL 24 51 115.4%
    ABB 610 1,283 110.2%

    So, what has caused the sudden surge in mid-cap stocks and why are investors - big and small - flocking to invest in these? While there is seemingly no definitive answer for this, we look at some of the parameters that 'could' have worked in favour of mid-cap stocks that led to the stock prices of numerous companies double, triple, quadruple, all within a span of 12 months.

    Key gainers over the year (CNX Mid-cap 200)
    Company Price on
    May 17, 2004
    Price on
    May 17, 2005
    %
    Change
    CNX MID-CAP 200 1,404 2,948 110.0%
    BEML 102 685 574.1%
    CROMPTON GR. 139 466 236.0%
    ISPAT INDS. 7 23 222.9%
    TITAN INDS. 89 275 207.6%
    GMDC 117 357 203.8%

    Strong FII/MF participation: This was seemingly the largest contributor to the gains that were witnessed in mid-cap stocks. While we do reckon the fact that large institutions prefer to invest largely in blue-chip companies, which have strong financial backgrounds to support their credentials and where there is a relatively higher degree of safety and predictability of future performance, the size of these companies seem to have been a hindrance. With even our biggest companies being miniscule when compared to international peers, most of the large stocks already had huge institutional stakes with limited possibilities of scaling up investments. This could have 'forced' these large investors to look beyond BSE-30 and NSE-50 stocks.

    Increased retail participation: There has been growing evidence of increasing participation by retail investors in the stockmarkets. This can be judged by the fact that the number of accounts at National Securities Depositories Ltd. (NSDL) in 2004 increased by 29% (Source: indiabudget.nic.in) to touch 6 m. Now, since retail investors are largely those who prefer to invest in 'low-priced' stocks, as a significant number still continue to believe that 100 shares of a small (and risky) company is better than 20 shares of an established player, they tend to focus more on the mid-cap and small-cap segment of the market. They are primarily lured by the potential strong returns that can be logged by the company (largely owing to the low base effect!).

    Apart from the above mentioned liquidity factor, there is no denying the fact that many (not all) second-tier companies have improved their operational performance considerably, which has been reflected in their improving financial performance over the last several quarters that have been aided by the improved demand scenario in a low-interest rate regime. In fact, many mid-cap companies in sectors like FMCG, pharma, software, textiles and engineering have actually given a real tough fight to the industry leaders and in the process managing to garner a share of the market at the leaders' expense. This has led to increased attention being generated towards mid-cap stocks.

    To conclude, while there could be many more fundamental and non-fundamental reasons that may have contributed to the rise in mid-cap stocks, we continue to believe that investing in this segment of the market is always fraught with risks. While we are not against investing in mid-caps, we have the view that smaller companies have a relatively higher chance of failing, which could either be, among many reasons, owing to their lack of experience or limited financial muscle to ward off competition, thus making their future rather fragile.

    While we do agree that non-large-cap stocks could be the stocks of the future, there is a high-risk premium attached to investing in such stocks. And to mitigate the higher risks, the most important point here is that no investment should be considered in any stock that is not well researched. It must be noted that strong fundamentals, viable business model and trust worthy management are amongst the key ingredients that go into making a strong research.

     

     

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