Largecap stocks are giving better risk-adjusted returns (RAR) than midcaps. A comparison of the RAR since mid-2005 shows that RAR scores are twice for Sensex stocks vis-a-vis that of mid-cap.
This is despite the fact that mid-cap stocks have demonstrated superior annual earnings growth of 17.1% during the period as compared to 16% for Sensex companies. Usually, returns of a stock are directly proportional to its earnings growth rate. By that logic, the above trend indicates a possibility of midcap stocks being relatively undervalued.
?Mid-caps stocks, in general, experience a higher volatility because of the lower liquidity. Some of the mid-cap stock returns may catch up or even overtake the broader market returns during an uptrend. However, during a volatile or downtrend market, they tend to show more volatility as it may be difficult to sell large quantity of such stocks unlike that of large-caps? said Piyush Garg, CIO (Chief Investment Officer) at ICICI Securities.
Usually, it has been seen that during a market uptrend, as the buying interest in the large-cap stocks saturates, investors try to capture value in the mid-cap space, which often results into a haste in buying mid-cap stocks.
?The demand for mid-cap stocks is seen to be rising in an uptrend since most of the large-cap stocks get filled up with the buying fury. This results into a lot of mid-cap companies individually outperforming the broader markets,? said Kislay Kanth, Head of Research at Mape Securities. When the market turns for the worse, these mid-cap stocks are the first to be dumped from the portfolio.
?There have been instances wherein mid-cap companies with competent corporate governance practices and good management trade at a deep discount to their historic valuation or half their book values or at an attractive dividend yields. However, it rests with the investors to do due diligence to find out such attractive mid-cap stocks,? added Garg.
Kanth also points out that since institutional investors, the dominant participants in the Indian equity market, don?t tend to invest in stocks below a certain market value, their trading pattern also add to the popularity of large-caps, which in turn affects its prices positively.
For the study mid-2005 has been taken as the base, since earning per share of BSE midcap companies are available from that period.