Investors who are investing in the stock market for quite a long time understand the risks and returns involved with the size of the companies, in terms of market capitalization. In believing so, they think that large-cap stocks are less risky than mid-cap and small-cap stocks. However, it is not entirely true! And you know why? Because in recent years, the mid-cap and small-cap stocks outperformed the large-cap stocks and considered as a good investment option to boost long-term returns. To be more precise, it all started out at the beginning of the crash in oil prices in the year 2014. Since then for three consecutive years, the mid-caps and small-caps performed really well.
How the Small-Cap & Mid-Cap Companies benefited from this?
- The dividends generated from the cheap oil and commodities led to a sharp fall in input costs.
- A small range of products & services of small and mid-sized companies made them less vulnerable to an overload of debt and equity. As a result, they succeed to maintain their ROE and ROCE at decent levels.
- Some small & mid-sized companies hold the potential to become large caps in the future.
But, now the small-cap and mid-cap stocks aren’t performing that much well since Jan 2018. The mid-cap index is down nearly 15 percent and small-caps were even worse. It is due to the reversal in the oil price fall and also due to the impact of the tax on the long-term capital gain (LTCG). But, still the mid-caps and small-caps stock hold the great potential. It is just the media which shows only the negative side. According to them, they are highly risky, fraudulent, and lacking in quality etc.
Thus, through this article, we will lay out some things which are required to consider while buying mid-cap and small-cap stocks.
Things to Consider Before Investing in Small & Mid-Caps Stock
- Checking for past performance of any mid-cap and the small-cap stock is very crucial. Only decide after checking the last 4-5 years of performance. If there is consistency in it, then you should invest. Otherwise, it would be too risky to invest in some small-cap sized company which hasn’t anything to display publically in its quarterly reports.
- Since the small-cap and mid-caps are extremely diversifiable. Hence, they are less vulnerable to economic cycles and bottom-up investing method is a better approach. Instead of focusing on the entire sector, you can put all your attention on the specific company. In doing so, don’t forget to ensure that the company you are planning to invest is adequately capitalized.
- “Are you prepared to invest in the small-cap stock funds?” Well, not so fast. It is not wise to rush into things. You gotta clear your thoughts on why you investing in mid-caps or small-caps. If you are looking for average market returns then you should go for large-cap stocks but if your plan is to outperform and get more than average market returns then you can consider investing in mid-caps and small-caps stock.
- Check for the company’s strategy on working capital. Like, “How the company managing it?” Because it is common in mid-sized companies that either they will get proper credit terms or not gets adequate bank financing. Thus, checking for working capital is important.
- Do a check for the company’s management and operation activities. “Are senior level executives exiting in a short span of time”? Consider this as one of the crucial stock market tips, whether you are invested in a large-cap sized company or small-cap sized one, if the company’s internal management is not stable then it is definitely not good news.
- Consider the performance of the company in bad times. If a small-cap sized company is performing in bad times and maintaining its pace then the company is worth to invest in and has the ability to outperform in good times. In fact, that’s the real test of a company’s business.
- Lastly, check for the no. of equity in the company’s book. If a company has too much equity then it is definitely not a good sign. With too much equity, a company will need huge profits to earn EPS.
Apart from this, follow the standard stock market tips & strategies and don’t forget to look for the stock liquidity. After all, you don’t want to get stuck.
Hope, this article helped you in a way you expected it to be. If you have any query or would like to suggest something in small-caps and mid-caps stock or related to them then don’t hesitate to mention in the comment section below. We would be happy to answer all your questions.
Note: All information & data provided in this article is for the educational purpose as well as to give general information on the finance & economy, not to provide any professional advice or service. Views & opinions are not biased against the company and do not affect any official policy or any other agency, an organization within the content.