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Does Investing in Mid Cap and Small Cap Stocks Provide a Better Return Over Time?

The face of the Indian stock markets has changed considerably in the wake of the pandemic. Mid cap stocks and small cap stocks have especially booked stellar returns for their investors since the market rally towards the end of March 2020. Several mid-cap and small-cap stocks outperformed their large-cap peers and recorded new record highs during the past one and a half years.

The inherent nature of the three types of funds, i.e., large-cap, mid-cap, and small-cap, has a huge correlation with the current winds of the stock market. Here is a rundown of why mid-cap and small-cap funds are designed to perform better when an investor decides to stay invested in the same over a period of time.

What are mid cap stocks?

Companies with a market cap between ₹5,000 crores and ₹20,000 crores are called mid-cap companies. These companies tend to be more volatile than large-cap companies. However, they might turn into large-cap companies in future. Mid-cap stocks have higher growth potential than large-cap stocks. Mid-cap stocks are good investments for investors comfortable with the extra risk in exchange for the higher growth potential.

What is a mid cap fund?

A mid-cap fund is a scheme that invests in equity or equity-related instruments of only mid-cap companies. SEBI defines mid-cap companies based on their market capitalization. According to the SEBI rules, all companies ranking between 101 and 250 fall under the mid-cap category.

Why should you invest in mid cap stocks?

Good mid-cap stocks provide the best of both worlds to an investor since they are less risky than small-caps and generate better returns than large-caps. This enables investors to reap the best risk-return ratio on their investments. Here are our two cents on why investing in mid-cap stocks performs better over a longer time horizon and are a must in your portfolio:

Profitability

Seasoned management teams, a profitable business, and higher earnings growth are all telltale signs of a good mid-cap fund. Companies that report higher gross and operating margins as well as enjoy a quick inventory and receivables cycle are bound to lead to higher profits. Well managed mid-cap stocks with strong fundamentals may have high growth potential.

Growth

Mid-caps reporting not just higher revenues but also registering higher earnings growth potential for its investors should be sought. This in itself will turn any mid-cap company into a large-cap one gradually. Investing in mid-cap stocks for the long term might bring considerable profits if these stocks appreciate and break into the large-cap category.

Financial Health

A strong balance sheet that points at a comfortable debt position of a mid-cap company is another important indicator of a good return for their investors.

What are small cap stocks?

The meaning of small-cap stock in India is a company that has a market cap of less than ₹5,000 crores. Market cap refers to the value of a company that is traded on the stock market. As these companies have a smaller size, they have high growth potential. The low probability of success is what makes them volatile and risky. When an economy is coming out of a recession, small-cap stocks are often outperforming.

What is a small cap fund?

A small-cap fund is a scheme that invests in equity or equity-related instruments of only small-cap companies. According to SEBI, all companies falling below the ranking of 250 in terms of market capitalization and having a turnover of less than Rs 500 crores are small-cap companies.

Why should you invest in small cap stocks?

Investing in small-cap stocks may have high returns but have a higher risk factor attached to them. However, an investment over a long period of time considerably mitigates the risk quotient, provided the companies are cautiously selected. Here are some reasons which make small-caps a good investment decision over a long-term horizon:

Potential to Create Wealth

Small-cap funds have outperformed their benchmark indices in the recent past. With the potential to turn into large-cap and mid-cap funds of tomorrow, an investor with a decent risk appetite should definitely include small-cap funds in their portfolio.

Diversification

Small-cap funds invest in emerging businesses of promising companies, which show potential to scale up in the future. They provide investors with exposure to niche segments such as sugar, textiles, construction, chemicals, etc., which leads to a well-diversified portfolio and spreading of risks.

Difference between mid cap and small cap stocks

Mid cap stocksSmall cap stocks
Market cap of ₹5,000 crores to ₹20,000 croresMarket cap below ₹5,000 crores
Higher growth potential than large-cap stocksHigher growth potential than mid-cap and large-cap stocks
Less volatile than mid-cap stocks and more volatile than small-cap stocksMore volatile than mid-cap stocks and large-cap stocks

How do mid cap and small cap funds perform in the long term?

Small and mid-cap stocks in India perform well during the economic recovery and benefit their investors from any inflation-related downturns. In line with this, as the economy revives and the government rolls out plans to support growth and infuse liquidity, both small-cap and mid-cap funds are set to record new highs. Well-placed companies backed by good management under these two categories have proved their resilience during the pandemic and generated good returns for their investors.

Mid-cap investors made twice the money that of large-cap investors in the last 17 months, while small-cap investors have been three times better than large-cap investors. (as of August 2021)

With an average return of 70% over one year in the mid-cap mutual fund category and a return of 114% recorded in the NIFTY small-cap 100, both these segments have proved their mettle as beneficial long-term investments.

However, investors should remain cautious and opt for an optimum mix of mid-cap and small-cap funds. They need to pay close attention to the financials of these companies and ensure a lower expense ratio to maximize the returns generated. Also, every investor has a different risk profile and wants to stay invested for different time horizons. Keeping this in mind, the exposure in mid-cap funds can be anywhere between 15-30% and 5-20% in small-cap funds. Lastly, every investor should review their asset allocation every quarter. The best way to do this is to get in touch with a wealth manager or a professional financial adviser who can provide the best guidance.

With WealthBaskets, you can invest in a basket of stocks and ETFs based on a theme, sector or idea. The WealthBaskets are created and monitored by leading SEBI registered experts. You get the stocks in your own Demat accounts and receive dividends.

FAQs

Which is better: mid-cap or small-cap?

Mid-cap stocks are less risky than small-cap funds but generate lesser returns than small-cap funds. There is no right or wrong answer. The desired asset allocation depends upon factors such as the risk appetite of the investor, time horizon, and customer profile.

Is it a good time to invest in small-cap funds?

Small-cap funds are a good investment choice if you have a decent risk appetite and want to stay invested for the long term. Also, the revival in economic growth post-pandemic shows an upward trend for the small-cap funds.

Why do small-cap stocks have higher returns?

Small-cap companies are risk-takers and can take advantage of current market trends to tweak their strategies. Due to this, they are in a better position to earn a higher return on investment (ROI) than their large-cap or mid-cap peers.

Does Investing in Mid Cap and Small Cap Stocks Provide a Better Return Over Time?

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Does Investing in Mid Cap and Small Cap Stocks Provide a Better Return Over Time?

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