Mutual Funds

Why mid-cap companies could be the leaders of tomorrow

Ravi Gopalakrishnan | Updated on January 05, 2020 Published on January 05, 2020

Probability of mid-caps outperforming large-caps increases as investment horizon widens

People who have made it big in their careers, once started as freshers. Be it any profession, the journey from ordinary to extraordinary is made possible due to talent, hard work and perseverance, despite the adversities that come along the way.

Mid-cap companies are also like these ordinary people, that have matured over the initial start-up phase and have sustainable business models with quality management.

How mid-caps can deliver

The mid-cap universe of stocks display divergent performance.

It requires analytical skills and investment expertise to spot a winner in the mid-cap universe that has shown resilience and has successfully manoeuvred across different markets.

High-quality mid-cap companies have delivered returns ranging from 10x to 100x in the past 10 years.

It is worth noting that some of these high-quality mid-caps eventually grow to become large-caps.

The mid-cap index, Nifty Midcap 100, has outperformed the large-cap index Nifty 50 consistently, over longer time horizons.

For example, an investment of ₹10 lakh each in Nifty Midcap 100 and Nifty 50 in January 2003, would have grown to approximately ₹2.23 crore in Nifty Midcap 100 and ₹1.39 crore in Nifty 50 in November 2019, the mid-caps outperforming the large-caps by about ₹84 lakh*.

The valuations of the mid-cap index have also significantly corrected from the peak levels of early 2018.

Mid-caps are currently trading at 15.9x price-to-earnings compared with 25.6x in August 2018 (Motilal Oswal India Strategy, dated September 26, 2019).

The mid-cap index PE is now at a significant discount to the large-cap index, indicating relatively better value in mid-cap stocks.

An analysis of the calendar-year performance of the indices since 2003 shows that typically the mid-cap index tends to bounce back significantly after one to two years of underperformance of the large-cap index.

We believe that this consecutive underperformance of mid-cap index is an opportunity for investors.

Who should invest

As the above data suggest, the probability of mid-caps outperforming large-caps increases as the investment horizon increases.

Such mid-cap stocks have also proven to be better multipliers in the long term, despite short-term volatility.

As such, investors willing to take risk may invest in a mid-cap fund, in a staggered manner, through SIP/STP for their long-term goals and should not be bothered with short-term volatility.

*Data as on September 30, 2019; Source: MFI Explorer. Data for the Nifty Midcap 100 TRI is available from January 2003; hence, the above analysis is done from the inception of the index. The market movement depends on various factors, and hence, it cannot be assumed that the correction is over.

The writer is Head, Equity, Principal Mutual Fund

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Published on January 05, 2020
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