Mid-Caps To Dominate Market Returns

Mid-Caps have created wealth for investors over the years and are extremely popular amongst retail investors. Investors are attracted towards mid-caps because of high growth opportunities offered by some of the quality names. Yogesh Supekar explores investing opportunities in the mid-cap space while highlighting some of the top performing mid-caps in recent years 

Mid-cap investing is one of the most rewarding experiences for investors globally. Going by historical data, mid-cap stocks have always offered better growth potential than the Large-Caps and at the same time have also offered better liquidity than the Small-Caps. Thus, mid-caps are almost always in a sweet spot owing to their liquidity and growth potential. If we check the performance of the BSE Mid-Cap index, it gives us a better picture of relative performance.

According to Rishi Kohli, CIO (Hedge Fund Strategies), InCred Alternatives, “The big trendline resistance of the last one-year consolidation that lies around 17,850 was touched on Tuesday, August 30 and this happening on a monthly closing is significant. The fact that the Bank Nifty index had broken above a similar trendline a month back and the Mid-Cap index has also broken above a similar trendline resistance a couple of weeks back and taken support there in the last two weeks’ decline and then bounced back strongly this week corroborates the medium-term bullishness in the Indian equity markets.” 

“In fact, the Mid-Cap index had retraced only 38 per cent of the rally from March 2020 to October 2021 in last year’s consolidation and then broken above the channel which is very bullish. The ratio chart of a Nifty Mid-Cap index to Nifty Large-Cap index has also given a medium-term breakout which is supportive of the bullishness in the broader markets and points to near-term outperformance of mid-caps to large-caps,” he adds. So, what are mid-caps and how to and how much to invest in them? 

Securities and Exchange Board of India (SEBI) has made it easy to identify mid-cap stocks for investors. According to SEBI, mid-cap stocks are the stocks of companies that rank between 101st and 250th in terms of market capitalisation. If it is still confusing to identify mid-cap, we have at least two popular indices often used as benchmarks for evaluating the performance of mid-cap funds, the BSE Mid-Cap and NSE Mid-Cap indices. These indices represent some of the top and commonly traded mid-cap stocks in the Indian market. As an investor one can always refer to these indices to identify commonly traded mid-cap stocks on the bourses. 

Mid-Caps in Favour

Mid-caps are popular as they are presumed to produce better returns because they are quicker to act than large-caps and are usually more financially stable than small-caps. One of the reasons why mid-caps are preferred over small-caps is the liquidity in mid-cap counters is much better and hence any individual investor with high net worth can invest large sums of money in a particular mid-cap counter. Says Chetan Tupe who is an HNI, “I remember wanting to park a large sum in a small-cap stock. I realised quickly that the spread was very high and there was just not enough liquidity in the counter to absorb the money I wanted to allocate in that small-cap stock”. 

“Ever since then I have shifted my focus to mid-caps. When it comes to quality mid-caps, liquidity is not an issue at all. I can invest without any fear of not being able to liquidate the position. Also, the bid and ask spreads are healthier when compared to small-caps. What is interesting is that the earnings are also a lot more predictable in mid-caps when compared to the small-cap companies. The problem with small-caps is that at times the earnings are so volatile that it is almost impossible to build conviction in the stock. Mid-caps have a proven business model and the promoters are a lot more established. I think if you have large sums of money to invest then the choice must be mid-caps. For small-cap stocks one should allocate lower amount of capital as compared to mid-caps,” he adds. 

Fund Allocation

It is depending on one’s risk profile that a decision should be made as to how much money should be allocated to mid-caps, small caps and large caps. If you are a high-risk investor, 50 per cent can be allocated to mid-caps and small-caps with at least 70 per cent of this 50 per cent being allocated to mid-cap stocks. If one is a low-risk investor, 90 per cent of the capital should be invested in large-cap stocks and only 10 per cent should be invested in small-cap and mid-cap stocks. Again, at least 70 per cent of the total capital assigned for broader markets can be allocated to mid-cap stocks. 

Allocation of capital should be a function of risk profile. Once the decision in terms of quantum of allocation to mid-cap stocks is made, the question then should be about how best to invest in mid-cap stocks. One way is to pick mid-cap stocks from the basket of mid-cap stocks that are listed on the bourses while constructing a multi-cap portfolio for yourself. This process however will need specific stock-picking skills and often requires hard work. The other way is to park money in mid-cap mutual funds. If you are not keen on mid-cap mutual fund scheme you can look at opportunities in mid-cap ETFs. 

Mid-Cap ETFs

For those who believe in passive investing and find it difficult to pick stocks and time the markets, ETF investing is one of the best options available. If you are wondering how to get exposure to mid-caps via ETFs, there is a tailor-made solution in the form of ETFs that invest only in mid-caps. Several mid-cap ETFs are seen available for those who want a low-cost investing option with focus on high quality and liquid mid-caps. The table below explains the options that are available for investors and highlights the performance in a recent period. 

We can see that most of the ETFs focusing on mid-caps have been able to outperform the BSE Sensex by a good margin. It is interesting to note that the BSE Sensex is up by ~4 per cent in one year as of August 30 while the mid-cap ETFs have gained up to 12.65 per cent in the similar period. Even the worst performing mid-cap ETF in the category i.e. ICICI Pru S and P BSE Mid-Cap select ETF is up by 5.35 per cent, outperforming BSE Sensex. 

Technical View : Nifty Midcap Index 

In the month of August, the Nifty Midcap-100 outperformed the frontline gauge by a wide margin and this outperformance continued in the first couple of days of September month. As a result, the Nifty Midcap-100 index logged the highest weekly close after January 14, 2022. It gained by 25 per cent from June 20 low. On a daily chart, it formed a higher top, but the MACD line and RSI are declining. These two major indicators have formed a negative divergence. 

Interestingly, the index has been moving along with the upper Bollinger band since July 07, barring couple of instances where it tested the 20DMA. For the last three weeks, it has been seen consolidating in a broad range. The stronger relative strength shows outperformance. It has also outperformed compared the frontline index as mentioned earlier and more importantly, it is firmly placed inside the improving quadrant of RRG against the broader Nifty 500 index.

With a sizable bullish candle formed in the last week, there is no weakness visible at the current level. The Elder impulse system has formed a series of bullish bars. The weekly KST and MACD lines are rising is a positive sign. Only a move above the level of 31747 will lead to a fresh breakout. If it can sustain above this level, the target is open towards 33640, which is the new high. Interestingly, the Nifty Midcap index on an average registered gain of 2.4 per cent in the month of September as regards data considered since the year 2005. 

Conclusion

These days when we hear experts throwing adjectives such as ‘resilient markets’, ‘fastest growing markets’, ‘fastest growing economy’, etc. we know they are talking about the Indian equity market and the Indian economy. Recently, we saw Nikhil Kamat, CEO of one of the largest discount brokers in India, tweet, “Almost every time the markets gap down, we have seen more investors logging in. Historically, it was the opposite. I guess this means huge buying interest. Even on the institutional side, local and foreign, private and public, there’s a lot of interest in India compared to others.” This is exactly what is happening with mid cap stocks in India. There is a huge buying interest in the mid-caps, be it FII flows, retail investors’ penchant for mid-cap stocks or the trend of investing via mid-cap ETFs. We find at least 34 mid-cap stocks trading near their 52-week highs. We find from the trending automotive sector stocks such as Ashok Leyland, TVS Motors, MRF, Cummins India and Bharat Forge trading close to their 52-week highs. 

From the banking space we have mid-cap banks like Federal Bank, IDFC First Bank, Yes Bank and Canara Bank trading near their respective 52-week highs. Overall, the market mood is of cautious optimism. However, in the broader markets the mood is much more bullish. The resilience of the Indian markets may have taken the market participants by surprise but it does not guarantee that the Indian markets will continue to shine amidst global turmoil. There are several reasons why the Indian markets continue to shine and one of the strongest reasons is expanding economic activity and a huge opportunity in the manufacturing sector in India. Inflation is not always bad for the stock markets. 

We have seen that umpteen times historically. As of now the goldilocks situation in the Indian economy with manageable inflationary pressures and increasing demand is seen creating wealth for stock market investors. Money flow is expected to increase for the Indian markets as corporates continue to report above average earnings’ growth. The quality of earnings and the emerging macro trends in few sectors such as defence, renewable energy, railways and manufacturing sector in India are creating extraordinary opportunities for investors in India. Long-term investors should not miss this golden opportunity to create wealth by investing in some of the top-quality mid-cap stocks. 

Research Methodology : 

To come up with a ranked list of mid-cap stocks, we took into consideration five crucial parameters. The first includes market capitalisation. The remaining parameters are obtained from the Profit & Loss Account and include Sales, Operating Profit and Net Profit. We also considered the PAT margin for ranking the stocks as it indicates how efficient a company has been in converting the given sales into profits. Each parameter was then ranked by awarding it a carefully determined weightage based on its significance. 

We then segregated the companies into three categories as follows: 

• Turnaround Performance: Turnaround Performance: These companies include those that successfully managed to turnaround the losses incurred in FY21 into profits in FY22. 

• Improving Financials: Although these companies still reported losses in FY22 as they did in FY21, they succeeded in reducing these losses by a notable amount. This indicates that they are on the road to recovery. 

• Thriving Companies: This list includes all the remaining profitable mid-cap stocks and their financial performance in FY22. 

A consolidated ranking was done in each category to arrive at the list. All the raw financial data is sourced from Ace Equity and price-related information is as of August 29, 2022.