Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
What is the risk in mid-caps? - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Sep 15, 2004

    What is the risk in mid-caps?

    In view of the huge rise that was witnessed in mid-cap stocks in recent times, last month we had done an article with the intention of pointing out some of the risks involved in investing in these stocks. That article was a larger perspective as to what we thought were the risks.

    However, just to take the exercise a bit further and focus on a relatively micro picture with respect to what investors consider a greater risk in investing in mid-cap stocks, we carried out a poll on Equitymaster by asking, "In your view, what is a bigger risk in investing in mid-cap stocks?" and the options provided were - earnings volatility, lack of information and management concerns. The results are depicted in the chart below.

    'Lack of information' (attention companies!) topped the investors' choice as a bigger risk of investing in mid-cap stocks with 43% of them opting for this. 'Management concerns' followed with 33% of votes with the balance 24% having gone in favour of 'Earnings volatility'. Let us now consider each of the above concerns in some detail.

    Lack of information: The dictionary defines the word 'information' as 'the communication or reception of knowledge (or intelligence)'. In the current context, communication is from the company and reception of knowledge is by the investor. And the only information dissemination platform for companies is the annual report and to some extent, the quarterly press release along with their quarterly performance report. Then it is at the investor's end to interpret and analyse the information.

    However, with respect to most mid-cap companies, unlike large-caps, the flow of information from the management is generally not at its optimum. Information could be pertaining to various facets of the company or the industry in which it operates and which is of absolute necessity to enhance the understanding about the company. Clarity over the source of revenues, segmental performance (if applicable), clarity over raw material inputs and their availability, market scenario - both domestic and international, etc. are just some of the factors that must form part of the annual report information.

    Further, one disadvantage for a mid-cap stock vis-a-vis a large-cap is the fact that the media actively covers the large-cap companies and as such, while the information regarding this is readily available, it is the information with respect to smaller companies that is a concern. An investor needs 'information' not only to take a rational and sound decision but also take calculated risk (to ascertain the risk-return profile) while investing in a stock. At this juncture, we would like to bring out an extract from the shareholder's letter (1985) of the legendary investor, Mr. Warren Buffet which read, "Management cannot determine market prices, although it can, by its disclosures and policies, encourage rational behavior by market participants."

    By not disclosing information proactively, some companies actually encourage the 'rumour float' that goes on in the markets. This is one of the key reasons for the investor losing his (her) shirt.

    Management concern: Our vote goes to this factor. We believe that a clear and untainted image of the management, in various respects, is of utmost importance. You wouldn't want a company, which is shareholder unfriendly, is profitable but invests the excess monies to diversify into absolutely unrelated fields of business, transfers monies to subsidiaries for investing in unethical practices (remember the number of companies involved in the Ketan Parekh stock market scam), management compensations are at unrealistic levels, etc. We would like to bring out here another extract from Mr. Warren Buffet's letter to shareholders (1984), "We feel very comfortable owning interests in businesses...that offer excellent economics combined with shareholder-conscious managements."

  • Also read: The 'Management' factor

    Earnings volatility: This is a key factor affecting the stock valuations of mid-cap companies. Owing to their relatively small size, volatile growth/de-growth patterns are almost immediately reflected in their stock prices and valuations. It has been seen time and again that mid-cap stocks display greater volatility and they are generally less liquid than the large-caps. The volatility in earnings could be attributed to the companies' inability to ward off competition or their inability to foresee business trends. Further, since the mid-caps have smaller turnover (partly due to their inability to expand and partly due to the lack of past track record), which could make them a relatively niche player forcing them to rely on a few clients/products for business.

    To conclude, while we do agree that mid-cap stocks could become potential winners in the medium to long-term (Infosys was also a mid-cap in the early stages of its growth), it is to be noted that there is a high-risk premium attached to investing in such stocks and investors will have to choose between the tradeoff of risk and return. The best metric for investing in such stocks should be a thorough research on the company's management and to gauge their expertise and ethics. If this parameter is fulfilled, then the other two aspects, i.e., lack of information and earnings volatility will wear off automatically.



    Equitymaster requests your view! Post a comment on "What is the risk in mid-caps?". Click here!


    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Why NOW Is the WORST Time for Index Investing (The 5 Minute Wrapup)

    Aug 18, 2017

    Buying the index now will hardly help make money in stocks even in ten years.

    Trump Takes a Beating (Vivek Kaul's Diary)

    Aug 18, 2017

    Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.

    How To Read Your Mutual Fund Account Statement Correctly (Outside View)

    Aug 17, 2017

    PersonalFN simplifies the mutual fund account statement for you.

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process) (The 5 Minute Wrapup)

    Aug 17, 2017

    A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms


    Aug 18, 2017 03:37 PM