InvestorQ : Over time, is it true that mid caps have outperformed the large caps and what is the reason for the same?
Riya Dwivedi made post

Over time, is it true that mid caps have outperformed the large caps and what is the reason for the same?

rhea Babu answered.
2 years ago

A simplistic reason is that mid caps are small and so they do better but that is too simplistic. The fact is that there are other reasons why these mid caps have done better than large caps. Let us look at some key reasons why mid caps outperform.

· Over-investment and debt were the key reasons why large cap stocks have underperformed. For example, business groups like Jaypee, Adani, Bhushan and Essar are saddled with loans in the range of Rs.80,000 to Rs.90,000 crore and we have already seen Bhushan and Essar being referred to bankruptcy.

· As growth and ROI have consistently slowed in the last 8 years, the debt burden came back to haunt in sectors like steel, power and infrastructure. Mid-caps were largely home-grown and hence did not have the capacity or requirement to borrow large sums, leaving them better off in the long run.

· Domestic Mutual Funds played a key role in identifying and building value in mid-cap stocks. For example, in the financial year 2015-16, FIIs infused $2.5 billion while DFIs infused nearly $11 billion into Indian equities. The biggest chunk of these inflows went into mid and small cap stocks, helping them reach better valuations.

· A sharp fall in commodity prices, especially Brent Crude oil was a leg up for mid caps. Most large caps were dependent on high oil and commodity prices to make profits. They did not really benefit from cheap oil. Mid-caps made the best of cheap commodities and enjoyed a much higher growth in profit compared to large caps.

· Mid-caps have always been more focused around their core competency and have not diversified too much. Mid-caps have avoided the urge to diversify due to paucity of institutional funds, which was readily available to the larger companies. For most mid-cap companies, focus on the core is part of their DNA, which is why former mid-caps like Infosys and Sun Pharma have stayed close to their core.

· This enables higher operating margins and better valuations for mid caps. Big bang GDP growth will mean that mid-caps will take the cake. At 7.5% GDP growth, India will add another $2 trillion to GDP by 2025. A chunk of these benefits are likely to accrue to mid cap companies which are growing. This trend will become more pronounced as India overtakes China on the GDP growth front.

· Last, but not the least, mid caps provide the much-needed alpha and hence can justify improved valuations. There are concerns on valuations of mid-caps but growth will take care of that. Typically, above normal returns have come from mid-caps transforming into large caps. Examples are Lupin, Britannia and Motherson Sumi etc. As the Nifty and Sensex get into a range, the alpha will be available only in specific mid cap and small cap stocks

In short, mid caps do have a distinct edge over the large caps in a number of ways.