Midcaps are companies that have a market capitalization (total market value of its outstanding shares) between Rs.5,000 crore and Rs.20,000 crore. The potential for today’s mid-caps to grow into future large-caps attracts investors. However, unlike the larger-cap stocks, where a lot of information is available, information is inconsistent on midcaps. As the investor is unable to analyse these stocks, they are not much popular among investors.
Mid-cap companies have potential to give handsome returns with 3-5 years investment horizon. Even while relating risk with size, midcaps offer a middle path. There are riskier than small caps and comparatively less risky than the large caps.
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The stock value is a function of its stock price and the number of shares. It is advisable to have a higher margin of safety or, to seek value that can ride out volatility. The margin of safety is the difference between the price you pay and the stock’s intrinsic value. Say, if the stock is quoted at Rs. 80 whereas, its intrinsic value is Rs.100, the margin of safety will be 20%. Higher safety margin means, lower risk and higher potential for growth.
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For Large-caps, you can find in-depth coverage and research. Thus, you can be sure about the quality of their management. However, mid-cap companies are generally under-researched. Thus, you need to be mindful of whether the company has the management bandwidth to take it further.
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Two ratios to be careful about are price-to-earnings (PE) and price-to-book value (PBV). An investor must be careful with the value traps of stocks with low PE or PBV. A high priced mid-cap stock may also be valuable. One must look at the previous profits by the mid-cap companies. While studying the company’s business, one should be sure that the net profits are a product of its business operations.
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Can you believe that Infosys and Airtel were once lesser-known companies. Today’s mid-cap company can be tomorrow’s large-cap company. To know a company’s growth potential one must focus on its return on equity (ROE), debt-equity ratio, interest coverage ratio (ICR) and, its institutional holdings. Growth potential and strong fundaments are what make the stocks buyable. Read more about return on equity here
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