Mid-caps vs. Large-caps

A query has been posted in the 'Comments' section by Antriksh Patel on the behaviour of stocks from different Market Caps viz., Mid-caps and Large-caps. The query is relating to why mid-cap tend to give superior returns as compared to large-caps.

Hi Viral,
Nice article once again. I eagerly wait for your articles to come.
One query related to stock market behavior - "Why do the mid-caps tend to give better gains then the large-caps; what is the logic behind this behavior. I have observed that the large - caps have hardly doubled whereas mid caps has multiple 3 to 4 times. I can't understand this."Kindly throw some light on this.

Thanks,
Antriksh Patel

The Bigger First:

There is a belief that Mid-caps usually out-perform Large-caps by a big margin. But there is a rider to this notion. Usually, mid-caps out-perform large-caps during times of extreme exuberance and optimism. The rally in mid-caps can not bloom in a great way until such times of confidence and drama as we're witnessing right now. Whereas, on the other hand, large-caps are foremost to lead the rally when there is change of sentiment from pessimism to optimism. The benefit of first flight to safety is usually reserved for large-caps with sound fundamentals during recessionary times.

A large-part of the market pie, in the initial period of change of sentiment, is savoured by large cap stocks in form of rally in these counters where fundamentals and financial positions are strong and sound. Once this rally graduates into such a mode that the valuations of the large-caps looks expensive, there is a shift in market attitude. They tend to shift their money from large-caps to mid-caps where the valuations might have lagged & there is some degree of safety on terms of stock valuations.

Bridging the Valuation Gap:

The rally from large-caps tapers to mid-caps thus bridging the ‘Valuation Gap’. But, for this to happen, most of the large-caps must be fully valued or to the extent that such big counters deserve to be rated at. Later on, as market participants find it hard to justify more sanguine valuations for these large counters, the large-caps become stable at their higher-end and the markets enter the consolidation zone or may be even a small correction.

Gradually, investors start flirting where the valuations are in 'Comfort Zone' i.e., in battered Mid-caps but with good fundamentals & performance. From then, the 'Circular Flow' among Mid-cap starts where the trend of rally in mid-caps circulates among themselves from one clutch of mid-caps to another thus attempting to make the rally more inclusive & universe in nature.

Small & Sweet:

Generally speaking, Mid-caps are those companies who are relatively in early stages of business as compared to large-caps. Many mid-caps may also be involved in fast growing businesses or even special Niche segments of the market with unique product/service offerings. These companies may also have fast growth potential on the back of smaller business volume and relatively smaller base of their balance sheet size.

All these factors tend to come in final calculation while determining the company’s growth rate and its stock valuation. And, lastly, market stability and exuberance also plays its part in the last say about stock price valuation in mid-cap counters.

Volume Game:

Where as, Large-caps are usually past this phase and are into big volume game and may not exhibit the same rate of appreciation in growth as may be mid-caps with smaller base of balance sheet size. A small company, which operates on a relatively smaller balance sheet size, can grow at the rate of a few numbers of times (example, double or triple). Where as, a large-cap company grows in terms of few Percentage number of growth (example, 30% or 40% growth) on its already high base of balance sheet size.

Law of Gravity:

Whatever goes up, has to come down. During times of pessimism, the Mid-cap stocks are the ones which take severe beating in comparison to large-caps. Those very same reasons which lead to a steep rise in stock prices of mid-caps can come at play to support the reasoning of the slump in their stock prices during pessimistic times. Smaller balance sheet size would facilitate relatively lower leverage to tap sources to raise capital during times of crises. During such times, the financial performance of mid-cap companies can witness sharp fluctuations on account of volatility in incoming orders for their businesses, ability to raise funds, flight of capital from equity investments, etc.

However, if the fundamentals of some selective Mid-caps are really strong and sound from all perspectives like growth potential, financial standing, corporate results and governance, ability to raise funds, operation in Niche segment of business line, high growth potential, etc., they can as well depict stableness & low fluctuation as may be attributed to Large-caps stocks. That's not all, they can as well provide superior returns during up turns as compared to large-caps and still exhibit strength on the downside during slowing times.

In short, investment in mid-caps provides potential to grab high returns with the rider of high risk involved in them if the bet does not fall right & the company faces problem in shift engagement and continuation of its normal business activities, especially during hard times.


Small-cap Call : Investment + Trading

Kalindee Rail Nirman (Engineers) Ltd.

Value Buy Zone: Rs.125-140 (CMP Rs.138)
Short-term Target: T1 Rs.158/-, T2- Rs.180/-
Time Frame: 45-60 days; Rationale: Rail Budget
Medium-term Target: T1 Rs.180/-, T2 Rs.230/-
SL for (Short-term) Traders: Rs.120/-


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