What next for mid & small caps?

Thu, 3 Mar Pre-Open

   Previous Close   

   09:30 am   

   11:30 am   

   01:30 pm   

   Closing   

If the year so far is any indication, mid and small caps aren't really having a blast out there. Their performance is nothing to write home about. Infact, they lag their larger counterpart, the Sensex by a good margin.

As per a leading daily, the BSE mid and small cap indices have lost a significant 19% till date since the start of the year. It isn't that the Sensex hasn't fallen. It certainly has but at 13%, its decline is slightly less severe as compared to the other two.

Of course, it will be too naive to come to definite conclusions for the year on just the basis of the performance for the first two months. But these numbers cannot be completely ignored either. Especially when they are likely to have a good reasoning behind them.

So, what exactly could be the reasons behind the underperformance of the mid and small cap indices? Investors' lack of faith we believe.

It should be noted that for the year 2010, both these indices were nearly neck to neck in terms of returns generated. The returns for all of them fell within a narrow range of 16%-17%. But come 2011 and a small gap has opened up.

We believe that much of the difference has to do with governance issues. The recent unearthing of a whole host of scams has left the investor belief in the mid and small cap space quite shaken we should say.

There have been scams galore, right from stock price manipulations to the 2G controversy to the loans for bribe scam. And all of this has had a negative impact on mid and small cap stocks. Infact, the gains that took a couple of years in the making went away in a matter of few trading sessions. And this is certainly not a good sign.

However, it should also be noted that this isn't the first and the last occasion where governance issues have jolted investors. Just as chaff will always accompany wheat, there will always be bad companies existing alongside good companies. The important part is to know the difference between the two and concentrating one's investments in the latter set of companies.

And this is isn't such a difficult job as it is being made out to be. All one has to do is devote some time. Among other things, a good company will come equipped with a long term track record of growing profits (preferably 10 years) and that too without a lot of debt on its books. Its management will have had a good track record with respect to capital allocation and also a burning desire to keep the source of competitive advantage for the company intact. If such a stock is bought at attractive valuations then an investor does not have to worry about the above mentioned comparison amongst different indices. They become irrelevant for him just as we pay very little attention to such movements. In investing, it always pays to stick with the simple and known rather than trying to predict the unknown and the esoteric.