How to select good mid-caps?

Unlike large caps, where there is no dearth of information, for mid-cap stocks, investors need to put in greater energies while doing their homework for identifying good long-term investment prospects - companies that will become much larger because of better opportunities, strong progress and robust growth.

As such, we outline some key guiding factors for selection of good companies from the mid-cap space.

1. Management: Unlike many of the larger companies, perhaps one of the major risks is that many of the smaller companies, barring exceptions, are family managed. Before investing, it is pertinent to understand the promoter group as a whole. The other things that we as a research house focus on is on the last five to ten year track record of the company, key accounting policies over the years, private placements of shares and how deep is the top-tier management.

2. Identify the leaders - Current and potential: Investors would do well to identify mid-cap companies that are leaders in their respective business operations. These companies are generally the larger ones from the mid-cap space and have better abilities to tide over volatilities that impact mid-size companies like them. When growth happens, these companies are much better equipped to consolidate their position and grow larger in size.

3. Identify niche and focused businesses: This is a very important consideration while researching mid-cap stocks. Operations in a niche space help companies to shelve themselves from competition while providing differentiation benefits to customers. There are niche companies in commodity sectors as well (like iron ore manufacturers, cement manufacturers with a strong regional presence, focused manufacturers in textiles, FMCG companies with strong brands, MNC companies with a strong parent support). At the end of the day, the concerned company should have capabilities to tide over business cycles.

4. Liquidity: As we have seen in the past stock market cycles, it is important that a investor is aware of the liquidity situation i.e. what is the free-float (non-promoter holding), the last one year average volume and the last one-year average value of shares traded. The traded value is important because at times, the share price can give a distorted picture of the liquidity situation (in fact, many institutional investors focus more on value traded than volumes traded).

Last but not the least, have a cap for your midcap exposure, no matter how adventurous you are! By cap, we mean, as a percentage of the overall portfolio, midcap should not be more than 30% to 50%. This discipline is very critical for investors in general. Ultimately, Rome was not built in a day!

"Growth means change and change involves risk, stepping from the known to the unknown." - Anonymous