What are midcap stocks?

Investors and market participants usually divide all listed companies into three broader categories – large-cap stocks, mid-cap stocks, and small-cap stocks. The categorisation is done based on the valuation that the market ascribes to a company.

Large-cap stocks are usually some of the most valued companies in the market, while small-cap stocks are some of the least valued companies. Whereas, mid-cap stocks are, as the name suggests, relatively mid-sized stocks.

Dividing up the listed companies serves various purposes, as similar size companies usually share some characteristics. Size also determines which stocks will be part of which index, and thus will get fund flow from index funds.

Size is determined by calculating the market capitalisation or market cap of a company. The formula for calculating market cap is the number of outstanding shares multiplied by the share price of a stock. If a company’s stocks are priced at Rs 100, for example, and outstanding shares of the company are 10,000, the market cap will be Rs 10,00,000 (10,000 x Rs 100).

What are midcap stocks?

There is no concrete or established method to determine which stock is a mid-cap stock. Some use ballpark figures to determine mid-cap stocks, such as those valued between Rs 5,000 crore to 20,000 crores, while others employ different methodologies.

Association of Mutual Funds in India (AMFI), an association of asset management companies that self-regulates mutual fund space in India, categorises mid-cap stocks as the 101st largest to 250th largest companies in the market by market value.

AMFI releases its list of large-cap, mid-cap and small-cap stocks twice a year. AMFI uses the last six month’s average market cap to arrive at the market valuation of the company for this purpose. All mutual fund companies use this list to fulfil their compliance requirement according to the category of the fund.

As per the latest categorisation list released in January 2023, companies valued between Rs 48,600 crore and Rs 16,800 crore were marked as mid-cap stocks. These thresholds dividing the companies into three categories change every six months as the market cap of companies changes.

Features of midcap stocks

Mid-cap companies usually have established businesses in the industry, but they are not the top players. However, they can be top players in a niche industry or in a particular geography. The growth opportunity for them is relatively much more significant than a large-cap company. In the stock market, a mid-cap stock is typically more volatile than a large-cap stock but much less volatile than a small-cap stock. The risk associated with mid-cap stock is also proportional to the volatility.

Below are some of the key features of a mid-cap stock:

Stable business

Mid-cap companies are those that have established their businesses and already found a foothold in the industry. They are usually one of the top players in a region or product category. They are also usually in the process of expanding their businesses. They usually generate stable revenue, but profits and margins may be volatile, given their costly expansion projects.

Focus

Most midcap companies in India are domestically focused unless they serve niche customers who are present mostly outside India. Even in India, they can be focussed on a particular region with an ambition to expand businesses in other regions.   

Growth opportunity

Midcap companies have relatively higher growth opportunities. Since they are not the top players in the industry and have mid-sized businesses, their hunger, and the scope to grow further is much more than larger peers. For many better-positioned companies, their expansion projects can be partly or fully funded through internal accrual, unlike small-cap companies, which mostly do it through raising debt or raising funds by selling equities. This helps them keep debt or equity dilution in control.

Risk

Unlike large-cap companies that have stable revenue and profit generation capabilities, mid-cap companies are more prone to fluctuations in profits and margins. Companies that are expanding may see a jump in profits, while those that are struggling may see their profits spiralling down for a few quarters. Thus, they provide a moderate risk to investors – more than large-cap stocks but less than small-cap stocks.

Mergers and acquisitions  

Establishing a new business is much tougher than buying an established business. Thus, mid-cap companies are also more prone to be targets of merger and acquisition by larger peers. Mergers can be value creative for shareholders leading to growth in stock price.

Why should you invest in midcap stocks?

There are several reasons for an investor to invest in a mid-cap stock, including higher return potential, wealth creation through long-term investment opportunities, and relatively lower risk.

Return potential:

As long as an investor picks good quality stocks from the mid-cap stocks, the return potential can be huge. Since these companies are in an advanced growing phase, the stock price moves swiftly in case revenue growth is high.

Pick of fund managers:

Most portfolio managers, also called “smart money” in the industry, tend to buy stocks from mid-cap space as they believe they give ample risk rewards to them. The key is picking the right stocks, most believe, and an investor can be on a long-term wealth creation journey.

Risks associated with midcap stocks

As there are advantages, risks are also there in investing in mid-cap stocks. The biggest risk can be that some of them can keep struggling for a long time. In such cases, your capital may see a big drawdown.

Another risk is that mid-cap stocks tend to have much less analyst coverage making it difficult for retail investors to know more about a company. In such cases, the probability of you catching a bad apple is higher.

Conclusion

Midcap stocks have the potential to offer investors attractive growth opportunities with higher returns than large-cap stocks. However, they can also be less risky than small-cap stocks. These stocks create good opportunities for savvy investors as they are typically less known and less researched. However, one requires careful analysis and due diligence to identify promising midcap companies with solid fundamentals and growth potential.

FAQs:

Q: What are midcap stocks?

A: Midcap stocks are stocks of companies with medium-sized market capitalizations, typically between large-cap and small-cap stocks. In India, midcap stocks are defined as those with a market capitalization between Rs 5,000 crore and Rs 20,000 crore.

Q: Are midcap stocks riskier than large-cap stocks?

A: Midcap stocks can be riskier than large-cap stocks as these companies may have less financial stability and may be more vulnerable to economic downturns. Midcap stocks can also be more volatile than large-cap stocks.

Q: How should investors analyze midcap stocks?

A: Investors can analyse midcap stocks using fundamental analysis. This involves examining a company's financial statement, competitive position, and growth prospects. It is also necessary to consider the industry dynamics and macroeconomic environment in which the company operates.