If you are an investor with a moderately high-risk appetite and one to seek long-term capital growth, you must invest in mid-cap stocks.
In this blog post, we are going to discuss what are midcap stocks, what are their characteristics, and what are the risks involved in investing in midcap stocks.
But before we go ahead, you can check out our Foundation Course On Stock Market to learn basic practical applications in the stock market, how to pick the right stocks, and how to make your stock portfolio.
What Are Midcap Stocks?
As per SEBI, mid-cap stocks refer to the stocks of publicly traded companies that rank between 101st – 250th company in terms of market capitalization, provided the securities are in the descending order of market capitalization.
The market capitalization of a stock will be the stock’s market capitalization on a stock exchange if only one of the recognized stock exchanges of India lists such a stock.
However, the stock’s market capitalization will be the stock’s market capitalization on an average on all stock exchanges if more than one recognized stock exchange in India lists such a stock.
Market capitalization (market cap) is simply the product of the number of outstanding shares and the share price of a publicly traded company. It is an important factor when analyzing and selecting stocks as it measures the size of a publicly traded company in terms of market value.
Market capitalization is an important indicator as it exhibits the market’s opinion of a company’s net worth. Furthermore, it is a basic determinant of various characteristics of a publicly traded company in which you are interested as an investor.
The mid-cap stocks are more volatile and susceptible to varying price fluctuations than the large caps. When the market rises, the mid-cap stocks rise faster than the large-caps. On the contrary, if the markets fall, the mid-cap stocks take a deep blow relative to the large caps.
However, the mid-cap stocks are less volatile and risky than the small-cap stocks. Often, they are referred to as the “sweet spot” of the investment universe as they may offer attractive investment opportunities for you as an investor at a lesser risk compared to the small-cap stocks.
Why You Should Invest In Mid-Cap Stocks?
Mid-cap stocks in India typically exhibit several characteristics that set them apart from large-cap and small-cap stocks. Here are some key reasons why you should invest in mid-cap stocks./
Growth Potential
Relative to the large-cap stocks, the mid-cap stocks have higher growth potential.
Though the mid-cap companies have successfully sailed through their early market development and growth phase and have already established themselves in their respective markets, they are yet to reach maturity.
Accordingly, mid-cap companies may still have opportunities to expand their market share, enter new markets, or introduce new products and services.
Otherwise, they may have a competitive advantage or unique positioning within their industry that allows them to capture market share and grow their revenues. It could be due to innovative technology, strong brand recognition, or efficient operations.
Risk Profile
Mid-cap stocks are generally less risky as compared to the small-cap stocks. That’s because medium-sized companies have successfully navigated the vulnerabilities of the growth phase of small-cap companies and have proven business models.
As a result, they offer more stable growth in earnings and dividends relative to small-cap companies.
However, mid-cap stocks carry a higher risk due to their smaller size when compared with large-cap stocks, though they can offer you the potential for higher returns.
Liquidity
Mid-cap stocks generally have higher trading volumes than small-cap stocks because they are better known. In other words, the mid-cap stocks, as compared to the small-cap stocks, exchange hands (bought and sold) more daily, thus contributing to higher liquidity levels.
When selecting a stock as an investor, liquidity is a factor you must consider because liquidity impacts the bid and ask spread in the stock’s price. How wide or narrow the bid-ask spread is, indicates how relatively difficult or easy it is to take or exit a position in the stock at the desired price.
Due to higher trading volumes and investor interest, mid-cap stocks may attract narrower bid-ask spreads than small-cap stocks. Narrower spreads make it easier for you as an investor to enter or exit trading positions at a desired stock price.
Diversification
Mid-cap stocks represent companies with medium-sized market capitalizations, falling between large-cap and small-cap stocks. You can diversify across various market capitalization segments by including mid-cap stocks in your portfolio.
How? Mid-cap stocks may offer exposure to different market dynamics and growth drivers compared to large-cap stocks. As a result, the mid-caps may be positioned to benefit from specific market trends, emerging technologies, or consumer preferences, providing diversification benefits beyond what large-cap stocks offer.
In addition to this, mid-cap stocks may have lower correlations with large-cap and small-cap stocks, as they often respond differently to market events and economic cycles. Thus, by diversifying across assets with low correlations, you as an investor can potentially reduce portfolio volatility and enhance risk-adjusted returns.
Under Researched
Many mid-cap stocks are under-researched by analysts as they typically focus their attention on large-cap equities due to their prominence in major market indices and their significant market capitalizations.
If you are an active mid-cap investor with deep analytical resources, such a relative lack of sell-side research provides you with an opportunity to seek well-positioned companies before their value is fully recognized.
As an active mid-cap investor, you can conduct your thorough research may uncover valuable insights or information that the broader market has yet to recognize. This information advantage can enable you to make more informed investment decisions and potentially capitalize on mispricings in the market.
Risks Of Investing In Midcap Stocks
Investing in mid-cap stocks can offer attractive growth potential, but it also comes with certain risks you should be aware of. The mid-cap stocks:
- tend to be more volatile than large-cap stocks due to which their prices can experience significant fluctuations in response to changes in market sentiment, economic conditions, or company-specific factors.
- have lower trading volumes than large-cap stocks, which makes it more challenging for you as an investor to buy or sell shares at desired prices, especially during periods of market stress or heightened volatility.
- maybe more exposed to business risk compared to more established companies as they may operate in niche markets, have less diversified revenue streams, or face intense competition from larger rivals. As a result, mid-cap stocks may be more susceptible to adverse developments such as changes in consumer preferences, technological disruptions, or regulatory changes.
- often receive less research coverage from analysts and institutional investors compared to large-cap stocks. This can create information asymmetry, where certain investors possess more information or insights than others. As a result, you may face challenges in accurately assessing the prospects and risks associated with mid-cap stocks, potentially leading to mispricings or investment losses.
Conclusion
While investing in mid-cap stocks can offer the potential for higher returns, you should carefully consider the risks of investing in mid-cap stocks. Diversification across different asset classes, market sectors, and company sizes can help you mitigate the risks of investing in mid-cap stocks.