Is it the Right Time to Buy Midcaps?

When Radhakishan Damani invested in HDFC Bank during the 90s, the bet was on a small private bank and an unknown guy by the name of Aditya Puri, who had quit his job from Singapore to head HDFC Bank.

Back in those days, 'service to customers' was a non-existent concept among the 'babu' cultured PSU banks. It was HDFC Bank that focused on customer service and personal banking along with its expansion strategy.

As they say, the rest is history.

When Raamdeo Agarwal invested in a small Delhi-based two-wheeler manufacturer Hero MotoCorp in the 90s, little did he know that in 10 years, with the help of its Japanese partner Honda, the company would become India's largest two-wheeler manufacturer.

We all know what Titan and CRISIL did to Rakesh Jhunjhunwala's wealth.

I can go on and on, about the India's finest investors and their multibagger stocks.

But the point I'm trying to make is different.

The disproportionate returns which stocks like HDFC Bank, CRISIL, Titan, Hero MotoCorp, and many more have generated, is solely due to the size of these companies at the time of investment.

Have you ever seen any famous investor make a fortune by investing in largecaps?

Large-cap Stocks: The Shock Absorbers of Your Portfolio

Outperformance in the stock market is achieved by investing in small and mid-cap companies.

To reiterate the point, HDFC Bank was a nobody in the banking world in the 1990s. Hero MotoCorp in 1990s, was an unknown brand. Titan was just another push by the Tatas in the jewellery segment which was dominated by small jewellers.

Apart from the vision and risk-taking ability which these investors had, all their multibaggers have been small and mid-cap stocks.

Big Wealth Creators Were Small and Midcaps 20 Years Ago

Company	Year	Market Cap
Titan	2005	US $ 0.75 bn
	2022	US $ 23.75 bn
Returns (times)		31.7
HDFC Bank	2001	US $1.5 bn
	2022	US $ 109.8 bn
Returns (times)		31.7
Crisil	2005	US $ 0.2 bn
	2022	US $ 3 bn
Returns (times)		15.0
Hero MotoCorp	2001	US $ 0.6 bn
	2022	US $ 7.2 bn
Returns (times)		12.0

Source: Equitymaster

A lot of people are of the opinion that largecaps are a relatively safe bet.

Many times we hear things like HDFC Bank or an Asian Paints will never fall beyond a point even during worst of times as value will emerge.

In a crash as serious as the Covid 2020 fall which was sharp and fast, stocks like HDFC bank and Asian Paints fell by 32% and 17% respectively. Mid-caps on the other hand fell by more than 50% in general.

While this is true, let's look at it from a different perspective.

Large-cap Stocks: The Shock Absorbers of Your Portfolio

From a portfolio construct, largecap stocks are always the shock absorbers. While the fall might be limited in these stocks, the rise too is limited.

When was the last time you heard that a large-cap stock double in a year (with exception of Reliance) or a large-cap stock having changed your fortunes?

I'm sure you've heard stories of people getting their children married or funding their overseas education with shares of MRF. Well, MRF in the 1990s was a small-cap stock.

Stocks like Pidilite and Bajaj Finance which have become large-cap stocks, were also mid-cap stocks 10 years ago.

Wealth creation happens when you invest in small and mid-cap stocks. Wealth preservation happens in large-cap stocks after wealth creation.

The recovery in small and midcaps is usually faster than largecaps too.

These stocks are more volatile than largecaps. Therefore they will fall more. However, during the up cycle they rise faster than largecaps. In fact, in terms of recovery from the bottom, small and midcaps rise much faster.

Midcap v/s Large Cap performance

	Nifty	Mid-Cap Index
2020 peak	12,250	15,900
2020 bottom	8650	10,220
Fall from peak	-29%	-36%
	Nifty	Mid-Cap Index
2020 bottom	8,650	10,220
2021 peak	18,600	27,240
Returns from bottom	115%	167%
	Nifty	Mid-Cap Index
2021 peak	18,600	27,240
Jun-22	15,200	21,295
Fall from peak	-18%	-22%

Source: Equitymaster

Some Food for thought

While finding the next multibagger, it's pertinent to learn from history.

Stocks or sectors which have been top performers in the previous cycle, seldom continue their outperformance in the future.

Classic examples are stocks like Eicher Motors or pharma companies which dominated the 2010-2018 cycle but have turned laggards now.

And that brings me to the current scenario...

The key word is 'Quality' Smallcaps and Midcaps

While the midcap index has corrected by 22% from the top in October-21, some quality midcap companies have fallen by 30-50% from the top. The best time to accumulate midcaps and smallcaps is during such times.

What should investors do?

While it's impossible to predict a bottom for the market, the focus should be on buying quality midcap companies in sectors listed below.

Consider Quality Midcaps from these Sectors

Sectors to Avoid	Neutral	Sectors to Focus on
Consumer durables	IT	Auto
Oil and Gas	Financials	Auto Ancillary
Chemicals	Banks	Real Estate
	Domestic consumption	Capital Goods

Source: Equitymaster

Warm regards,


Aditya Vora
Research Analyst, Hidden Treasure

PS: With midcaps clearing turning attractive, I believe quality mid-cap stocks are likely to outperform expensive stocks with astronomical valuations.

The so called 'Coffee Can' portfolio has been underperforming, with valuations resetting against high PE stocks.

Here is a look at my video on Coffee Can Investing and why you should stay away from it.