Indian stock markets witnessed a dramatic fall in March 2020 once the government declared a lockdown. However, the markets rose back in a short span and quite spectacularly too thanks to investors adding a healthy dose of mid-cap stocks in their portfolio holdings.
However, unlike large-cap stocks, mid-cap stocks come with a dual edged sword of higher growth potential and higher risks. Before investing in them, it is necessary that an investor must understand the fundamentals of the company and the current state of the markets as well as the macro-economy.
Here is a list of 10 factors to watch out for before you add more shares to your mid-cap portfolio:
Liquidity comes first and foremost when it comes to mid-cap investing. The investor must ensure that he can exit the stock before it takes too much price damage. Retail investors should be mindful of stocks where mutual funds or proprietary traders have purchased huge quantities. These shares are prone to a fast selloff and major, unanticipated price damage.
2. Past performance
A consistent track record of good performance in the past 4-5 years is a valuable indicator of the stability of the company. An inconsistent track record and a P&L statement saddled with losses and sinking revenues is a red-flag.
3. Vulnerability to macro factors
Assess the pressure points of the company you are investing in. Mid-cap stocks in auto-ancilliaries perform badly when demand in the auto sector plummets. Mid-cap metal stocks are exposed to global over-supply or raw material price variations. Look at the macro factors to understand the risks your stocks face.
4. Returns from mid-cap stocks
Mid-cap shares should be seen from a different lens than the one used for Nifty and Sensex. Returns from benchmark indices should ideally not be compared to mid-cap shares. Mid-cap stocks should be held for their potential to deliver absolute returns.
5. Keep tabs on mid-cap exposure
Depending on your risk tolerance levels, determine the total exposure you wish to have to mid-cap stocks and stick to it. Say, you decide to allocate 30% of your portfolio to mid-cap stocks, then stick to the limit. If you exceed the limit, book profits and ensure that you limit the exposure to the original cap.
6. Screen the management and corporate governance
Mid-cap stocks have had their fair share of bad news coverage for lack of corporate governance and mismanagement. Ensure that the companies you invest in have robust internal mechanisms and high corporate accountability. A strong management team is indicative of a well-oiled, well-managed company.
7. Monitoring risks comes before managing returns
In mid-cap stocks, the risk is measured from the point of view of volatility. Focus on stocks with better risk-adjusted returns. Once the investor manages the risk, he can expect a good return. However, pumping up risks in lure of a high return is akin to putting hard-earned capital on the line.
8. Avoid stocks with heavy pledging
Instead of being pulled in by high returns, retail investors must keep an eye out on stocks with more than 50% promotor pledging. These shares are quite vulnerable to price disturbances once the promotor fails to bring in additional margin and the lenders start dumping the stocks.
9. Watch out for regulatory circulars
In the past, the action of the market regulator SEBI has had quite an impact on mid-cap stocks. In 2018, three circulars issued by SEBI triggered a free-fall in mid-cap stocks. Investors must watch out for SEBI’s regulars when investing in mid-cap shares.
10. Observe how mid-caps perform during the bearish phase than the bullish
Bad times separate the wheat from the chaff. During bullish phases, investors flood the market with liquidity and the fundamentals of the company are often drowned out. It is only during bad times that the mettle of the company is truly tested.
You can start investing in mid-cap stocks by opening a demat account with Motilal Oswal. Motilal Oswal gives you hassle-free, seamless online trading experience with competitive brokerage plans.
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