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You would be hearing a lot, about the run-up in prices of small and mid-cap equities and the stress test the Securities and Exchange Board of India (SEBI) asked Mutual Funds to conduct on small and mid-cap funds. This article will help you make sense of what is happening.
Market capitalisation is the total value all shareholders have assigned to a firm listed on the stock exchange. It is computed by multiplying the market price of a share with outstanding shares.
As an illustration, the market price of MRF Ltd. is about ₹1,40,400, subject to daily fluctuations. This does not mean MRF is the most valuable stock in the country; it is the priciest
MRF’s market capitalisation stood at ₹46,200 crore in December 2023, which had risen in March, along with rise in stock price. The most valuable firm in the market viz. the one with the highest market cap is Reliance Industries.
“The market cap of Reliance was ₹16.4 lakh crore in December, which had risen in March, along with a rise in stock price. This shows the contrast between the firm with the highest market cap and the priciest stock. When the number of shares issued by the firm is relatively on the lower side, the value tends to get distributed, pushing up the stock price.
Relevance of concept
While there may be many parameters for categorising firms, market cap is popular. As the size of a business grows, the market assigns a higher value. That is referred to as large cap in the market. When the size of a business is small, only a limited number of stockholders are interested in it and the value is relatively lower. That is referred to as small-cap stock. In between, there are mid-cap stocks. Now the question is, what is the definition of large- or small-cap stocks. Equity analysts/fund managers have estimates and assume a number, beyond which the company is classified as a large-cap or mid-cap.
For categorisation, there is a definition from SEBI that is applicable to mutual funds but can be taken as a proxy for the entire market. The definition counts the top 100 listed stocks, as per market cap, as large-cap stocks.
The next 150 i.e. from stock number 101 to 250, are categorised as mid-cap. Beyond this, all stocks are classified as small-cap.
To give you a perspective, the stock ranking number 100 (border line of large- and mid-cap) as on December 2023 had a market cap of ₹67,000 crore. The one ranking 250 (border line of mid- and small-cap) had a market cap of ₹22,000 crore.
As per market terminology, there is another category viz. micro-cap. Firms that are small and vulnerable, which can be gauged from the relatively lower value assigned by the market, are referred to as micro. The implication is large-cap stocks are well discovered by market participants, the business is stable, upside scope i.e. market price moving up is there, but only so much, as the business is already tracked by a large section of the market.
Higher risk
On the other hand, in small-cap stocks, the potential for the firm to grow and along with it, the stock price, is relatively higher. However, the risk is also higher as the firm is yet to gather critical mass and the vulnerability to business failure is relatively higher. Stock-market performance shows over a long period of time, small-cap funds offered by the Mutual Fund industry has delivered returns higher than large-cap funds. However, the volatility, as measured by the standard deviation of the returns, is higher in small-cap funds.
The implication is you should have some allocation for small-cap stocks/funds in your portfolio.
However, it should not be a major allocation of equity component of the portfolio. Over the last one year, small-cap stocks performed significantly better. While this is good for investors, volatility risk is even higher now at these levels
At this juncture, SEBI asked mutual funds to hold stress tests on small- and mid-cap funds. MFs declared how many days it would take them, if need be, to liquidate 25% and 50% of the portfolio.
You need not take any action based on this — the fund that would take a longer time to liquidate is not necessarily that bad.
You need to look at the allocation to small- and mid-caps in your portfolio and re-evaluate, in light of the current stretched valuation levels. Consultation with your advisor/MF distributor would be useful. DIY investors would have to gauge it for themselves.
(The writer is a corporate trainer (financial markets) and author)
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