Mid cap stocks and small cap stocks have had a dream run in the last 3 years. To be more precise, the run in mid caps and small caps began with the crash in oil prices beginning 2014. For 3 consecutive years, the mid caps and the small caps vastly outperformed the large caps. There were 3 reasons for the same. Firstly, the dividends of cheap oil and commodities led to a sharp fall in input costs. The small and mid-sized companies benefited the most from this trend. Secondly, the mid caps and small caps have traditionally been companies with a narrow product or service focus. That has made them less vulnerable to an overload of equity and debt. Hence they have been able to maintain their ROE and ROCE at more attractive levels. Lastly, it is these mid caps that hold potential to become large caps in future. Stocks like Lupin, Britannia, and Titan are all cases in point where small and mid cap stocks metamorphosed into large cap stocks
The performance of the mid caps and small caps has been quite disconcerting since January 2018. While the Nifty is by 4.8% since Jan 2018, the Mid-cap index is down nearly (-15%) in the same period. Small caps have done even worse. This is partly due to the reversal in the oil price fall and also due to the impact of tax on LTCG as well as special margins imposed by exchanges on these stocks. But the fact is that they are the stocks that can provide the alpha. However, here are 10 points to keep in mind while investing in small and mid caps.
Lastly, focus on stock liquidity in the market and the basis risk. You surely do not want to get into a stock and then realize that you are stuck for good. That is best avoided. Focus on spreads, basis risk and also the available liquidity. Above all, ensure that the impact cost of your transactions on the stock is minimal.
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