5 Things to Monitor After You Have Invested in Mid-cap Stocks

Between 2015 and 2017 mid-cap and small-cap stocks consistently outperformed large caps in India. However, from 2018, mid-cap have been consistent underperformers and have also given negative returns. During the 2015-2017 mid-caps benefited from lower oil prices and a stable rupee. However, the mid-caps took a hit in 2018 because of the tax imposed on long term capital gains and the additional special margins imposed by SEBI. But over a longer period of time, mid-caps are a must as they give you the much needed alpha in the portfolio. The challenge is to monitor your mid-cap portfolio closely with a different set of parameters. Here are five things to monitor about mid-cap stocks.

Monitor the financials of mid-caps on a quarterly basis

Typically, mid-cap companies tend to be focused single product companies. This focus works to their advantage as their resources and management bandwidth does not get frittered away. However, the downside is that it tends to make their products and their business fortunes cyclical. You need monitor if there is any faltering on growth in sales volumes, growth in profits or in the operating margins. This consistency lies at the core of mid-cap investing. This is important because your investment selection process in mid-caps is normally bottom-up and not top-down.

Are the mid-cap returns outperforming the index?

When you invest in mid-caps, benchmarking is very critical as it puts the performance of the company and the stock in perspective. Invest in mid-caps for the alpha and not for the Beta. Hence mid-cap stocks need to be constantly benchmarked with the index, the large cap universe and also the peer group. After all, mid-cap stocks entail a higher risk and should also give higher returns.

Make it a point to monitor liquidity of the mid-cap stock

This is an important parameter to track, especially with respect to mid-cap stocks. Liquidity is the Holy Grail for mid-cap stocks and it must be monitored on 3 fronts. Firstly, whether sufficient liquidity is available in the market and there is enough floating stock. Secondly, if the bid-ask spreads are narrow enough to reduce your cost of Trading. Finally, check for the impact cost. A reasonably large size order to purchase or sell the stock should not move the price significantly. That could work against you.

Management quality and corporate governance hold the key

In the last one year, we have seen a lot of mid-cap stocks taking deep cuts. Stocks got battered for various reasons ranging from the resignation of auditors to non-disclosure of group transactions to the management taking on excessive risk without informing shareholders. These are issues of management quality and of corporate governance. In the last few years, the issue of corporate governance has come to matter a lot more in the case of mid-cap stocks where the research coverage is limited compared to large caps. The negative reaction to corporate governance lapses is severe in case of mid-caps and hence that needs to be monitored closely.

Focus on how mid-caps hold value in tough times

The art of buying mid-caps is all about separating the wheat from the chaff. Focus on the mid-cap stock performance in the downturns rather than in the upturns. This is important for 2 reasons. Firstly, mid-caps normally outperform in a good market and hence stock quality gets hidden in good times. A down market presents a clearer picture. Secondly, in a down market the ability of the company management to handle risk becomes more critical and that separates the wheat from the chaff.

Last, but not the least, in any mid-cap portfolio you need to be cautious because there is a limit to the number of quality mid-cap and small-cap stocks available in the market. In fact, you must also track if funds or FIIs are selling these mid-cap stocks as that can have a profound impact on the prices of these stocks. The bottom-line is that mid-caps are a must for every investor for that much-needed alpha boost to your portfolio. A better understanding of the nuances of monitoring a mid-cap portfolio can help you make better and smarter decisions in the stock market.