Mid Cap, Small Cap & Large Cap: The Right Cap For Uncapped Growth
May 11, 2018 | 17:52 PM IST
May 11, 2018 | 17:52 PM IST
Midcap, Smallcap & large Cap, you must have read these words on the financial portals or even while sifting through your newspaper. What do they mean? What is a cap? You would not care to learn more about these terms if you are not interested in finance and corporate affairs. But then the same terms pop up when you try to find out about mutual funds and SIP. Now that it's a matter of your hard-earned money, it becomes important to understand what relevance these "caps" hold in your investment. The fact is, those who have a fundamental knowledge of market caps enjoy more clarity in their financial planning.
Let's explore the multiple caps of the stocks and try to understand why they are so important in your investment.
What Is Market Cap?
Market cap is a contraction of the term "market capitalisation". Market capitalisation is the total valuation of the company based on the company's current share price and the total number of outstanding shares. Finding the current market cap of the company is simple. You get the market cap by multiplying the current market price of the company's share with the total outstanding shares of the company. For example, a company has 2 crore outstanding shares and the current market price of each share is Rs.100. The market capitalisation of the company will be 200,00,000 x 100=Rs.200 crores.
There are many companies of various sectors listed in a stock exchange and their market capitalisation and total outstanding shares are different from each other. Based on the market capitalisation of a company, all the listed companies are categorised into 3 broad segments - Large Cap (Also known as Blue Chip stocks), midcap and small cap.
Companies that have market cap of Rs.10,000 crore or more are considered large-cap stocks. Companies with the market cap between Rs.5,000-20,000 crores are mid-cap stocks while those with less than Rs.5,000 crore market cap are small-cap stocks.
Though every stock behaves in its own unique way, there are certain characteristics which are similar in stocks belonging to the same cap. For example, TCS stock (Large-cap) will have less return on equity than Hexaware Technologies (Midcap). But TCS is still considered more stable than Hexaware Technologies.
These are just generalisations, now let's take a deep dive in the concept of market caps and try to figure out what makes one different from other and how you should look at them while building your stock investment strategy.
Large Caps: Solid As A Rock But Just As Slow
Large-cap stocks usually have big and well-established companies that have a substantial market presence. Such companies are generally considered as safe investments. Large-cap companies have a long history and have robust financials with high dividend yield. One of the reasons these companies are considered a safe investment is that they are run by highly experienced promoters and management team.
Also, one of the reasons that they have become so big is that they have been efficient and innovative in their operations and money management. The good thing about investing in large caps is that the information about these companies is easily available on internet, newspapers and financial portals. All their financial and corporate activities are closely monitored by the financial media which makes it easy for the investors to track all the details.
Key Characteristics -
- Stable yet slow movers
- High dividend yield
- Healthy financial ratios
Stocks - TCS, Infosys, Wipro, Tata Motors, Hindustan Lever
Weight In Your Portfolio - Stability is the cornerstone quality of large-cap stocks but it doesn't make them immune from the market volatility. Large-cap stocks should be bought with a long-term view as they do little in terms of growth but pay regular dividends. The chances of stocks splitting and bonus shares are high in blue-chip stocks which increases the value of your investment. If you have an aggressive risk appetite then you can have 20% large-cap stocks in your portfolio. Investors with moderate risk appetite can have 30-35% large caps stocks.
Mid Cap: High On Growth, High On Risk
The second tier in market caps is Midcap. The growth potential of the midcap stocks is one of the reasons why they enjoy high volumes in the day-to-day trading. No wonder this segment is regarded as the darling of the investors. Mid-cap stocks are of those companies which have a market capitalisation in the range of Rs.5,000-10,000 crore. Mid-cap companies are considerably smaller than large-cap companies in terms of revenue, profitability, employees, client base, etc.
It's not only about size and profitability, but the most critical differentiator is that the mid-cap segment comprises of the stocks that are comparatively riskier than large-caps. The factor that draws investors to mid-cap stocks is the opportunity of investing in a company that could become an overnight success multiplying their capital manifolds.
These are the emerging companies with aggressive production, marketing and delivery strategies. As these companies are in the growth stage, there is a huge scope for expansion and increasing bottom line which translates into high profits, of the stockholders.
However, the high returns come at the expense of the high risk. The businesses which are aggressively galloping ahead are always susceptible to steep failures. These stocks pose a high risk as all the companies in this segment have to compete with fierce peer group companies and the demand-supply equation keeps changing on the everyday basis.
Key Characteristics -
- Highly volatile
- Emerging businesses
- History of steep price movements
Stocks - DHFL, GNFC, Indiabulls Housing Finance, Hexaware Technologies
Weight In Your Investment - Every investor should have at least 50% mid-cap stocks in his/her portfolio. These stocks have enormous growth potential and can change the face of your portfolio in considerably less time provided you have chosen right stocks. Rapid capital appreciation is one of the key qualities of midcap stocks.
Small Cap: Too Much Risk!
Lying at the bottom of the funnel is small-cap. Small caps are not necessarily dangerous or untouchables but as these are new companies with small market cap and a smaller client base they don't have the financial strength to survive bad times. Having said that, there are many small cap companies which have reported big profits and their stocks have turned multibaggers. These are the companies which have skilled management, competitive marketing strategies and disciplined money management. To gain from such companies it is important to identify them when they are undervalued. The price movement of these companies is ferocious. Therefore, buying such stocks when they are overvalued or even fairly valued can be extremely risky. It is important to exercise utmost caution while buying small-cap stocks, it's advisable to get a professional advice from your financial advisor before entering any such stock.
Key Characteristics -
- Rapid price movement
- High probability of stock getting stuck in upper/lower circuit
Stocks - South India Paper Mills Ltd, Visaka Industries Ltd, Repro India Ltd
Weightage In Your Portfolio - Small-cap stocks are for those who can handle high volatility. In your portfolio, their role is to accelerate the growth meter. Those with moderate risk appetite should not touch small-caps. They should go by 60% midcaps and 40% large caps. Those with aggressive risk appetite can have up to 20% small caps. The ideal portfolio alignment should be 20% Large Cap, 20% Small Cap and 60% Mid Cap.
One Cap Better than Other?
After learning about different market caps, the follow-up question that comes to everyone's mind is - is one cap better than other? "Are mid-caps stocks better than large caps?" Looking at the phenomenal performance of midcap index in 2017, it is natural for every new investor to think that midcaps are growth-oriented stocks and have a better chance of multiplying your capital. But looking only at the growth aspect of a stock is not enough.
Strike A Perfect Balance?
For Indian equity markets, 2017 was a phenomenal year, especially for mid and small-caps. The numbers tell the story. Sensex gave 27.5% in 2017 while for BSE Midcap was way ahead with 46%. And with 58%, BSE Small Cap outperformed all other indices.
When the markets turn highly volatile, mid-caps and small caps are the first to face the heat, while large-cap can be considered a little less risky. However, this theory is not entirely reliable.
The answer to the million dollar question "which category can be considered less risky and at the same time has the potential to give high returns" lies in proper asset allocation. It is advisable to all the investors entering the equity markets to be cautious while allocating money to the stocks. It's not a mere question of whether midcaps are better than large caps, it's the question is of your investment approach.
The point to note here is that the current trend of mid and small caps outperforming large caps started in 2013. This has led many investors to believe that midcaps always deliver better returns than blue chip companies.
This is where most of the invbehavioralbe seen falling into a behavioural trap as they drive their investment believing that this outperformance trend will continue forever.
As a result, they keep deploying their money exclusively to mid and small-cap stocks. This investors' behaviour is responsible for bringing many midcaps stocks in an overbought and overvalued condition. When certain stocks become overvalued, it means they are commanding a premium which is not justified by their business and earnings. Such stocks eventually correct and come back to their fair price. We witnessed this situation post-Union Budget when the entire midcap index corrected significantly.
Midcaps Were Far More Attractive In 2013
In 2013, many investment experts were fiercely advocating the case of investing in small and mid-cap stocks as there was a genuine reason of the valuation gap between large-cap and mid-cap stocks, which was quite wide back then.
However, the five years time horizon has changed things. The same experts will now be less upbeat about small and mid-cap stocks as they believe, they have run up quite a lot and most importantly, the valuation gap does not exist anymore.
Looking at history, even if the recent time favours mid and small caps, we can not conclusively say that mid and small caps will always outperform large caps in the long run.