Mid-caps for high returns

There was a little known company is a new sunrise industry called telecom in 2002. The company’s promoter was a first generation entrepreneur with many unsuccessful forays into business behind him. Not many analysts wanted to back him in 2002 when the share price of the company was quoting at Rs. 25/-. Today it’s a favourite stock of the investing community. If you had invested Rs. 10,000/- in this company in 2002, by 2007 your 400 shares would have be worth Rs. 3,32,000/-. A return of around 32 times in just 5 years!!!

What is so unique about such companies? How is it different from other stocks that have given “average” returns? It belongs to a category of stocks called mid-caps. Legendary stocks like Infosys and Wipro too were mid-caps sometime ago. Returns generates by these stocks are part of folklore today

What is midcap

As the name implies, mid-cap companies are in the middle of the pack. Their market capitalization is neither too large like the index companies nor too small to be treated as an inconsequential company. By definition a market capitalization is the product of the numbers of shares issued by the company and the market price of the company. In India a stock is called mid-cap if its market capitalization is anywhere between Rs. 500 to Rs. 2000 crores. However one should keep in mind that classifications such as "large-cap" or "mid-cap" are only approximations that can change over time.

Share price a reflection of growth

Generally speaking, mid-cap companies have the ability to produce greater returns through more compact and dynamic businesses that tend to be more growth oriented than larger conglomerates. Given the right economic environment and smart management, mid-cap companies have the potential to become large companies very quickly. Simply put, a company with a market cap of Rs. 500 crores, can easily double its entire market cap as compared to a large conglomerate of Rs. 50,000 crores. As share price is an important factor in measuring market cap, a rapid growth in a company most often than not translates into the price of the stock and market cap climbing higher.

Risk reward tradeoffs

Mid-cap companies rank higher in the risk return parameters as compared to large companies. Their ability to generate higher returns duly compensates for the additional risk involved. The beta of mid-caps is usually higher than 1 indicating that the share price of these companies rise faster in a bull market and fall sharply in a falling market. When compared to small-caps mid-cap companies they entail less risk, because they are slightly larger in size. The logic is that the mid size companies can last longer than small ones in difficult times. Their share prices are also usually not as prone to violent swings as small caps.

Choosing the right stock

All mid-caps do not give returns. For example the same Rs. 10,000 invested in a textile company in 2002 would be valued at approximately Rs. 18,000/- only in 2007 a return of 1.8 times in five years. Identifying a fledgling tree that will go on to become a great Oak involves lot of hard work. Some of the parameters for identifying them would be the industry segment, enterprising and aggressive management and sustainable top-line and bottom-line growth.

Great investment vehicle

Mid-cap can be great investment vehicles for investors seeking greater returns - without the risk of small caps - and index-related returns like those of large caps. The conclusion is that in years of moderate index returns, mid-caps can often produce more significant returns than their large-cap counterparts.

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