Here is what you can do!
Indian investors had a dream run in the last few months. However, something changed recently – small and midcap stocks have seen a major correction – something which most investors have not seen in the market – especially the ones who are new to the market. In this article, we look at the details, and at the end, we will tell you what you can do in such a situation.
What are small and mid-cap stocks?
First things first, let us understand the category. Small-cap stocks typically refer to companies with a relatively small market capitalization. There’s no strict definition, but small-cap companies are often those with market capitalizations up to Rs 5000 crore. These are generally considered to be riskier investments compared to large-cap or mid-cap stocks, as they are often newer or less established companies with potentially higher growth prospects but also higher volatility.
Mid-cap stocks, as the name suggests, are companies with medium-sized market capitalizations. Again, there’s no strict definition, but mid-cap companies generally have market capitalizations ranging from around Rs 5000 crore to Rs 20,000 crore.
What are the risks and rewards associated with them?
Here’s a breakdown of the risks and rewards associated with investing in small-cap and mid-cap stocks. Once you understand them completely, then only jump in them.
Rewards:
Higher Growth Potential: Small-cap and mid-cap companies are often in their early stages of growth or in industries with significant growth potential. As these companies expand and increase their market share, their stock prices may experience substantial appreciation, leading to potentially higher returns for investors.
Ability to Outperform: Historically, small-cap and mid-cap stocks have demonstrated the potential to outperform large-cap stocks over the long term. This outperformance can be attributed to their ability to grow at a faster rate due to their smaller size and flexibility.
Risks:
Higher Volatility: Small-cap and mid-cap stocks tend to be more volatile than large-cap stocks. Their prices can experience significant fluctuations in response to market sentiment, economic conditions, or company-specific factors. This volatility can result in rapid price changes, leading to higher risk for investors.
Higher Risk of Business Failure: Smaller companies may have limited financial resources and operational capabilities compared to larger, more established companies. It makes them more susceptible to business risks such as competition, regulatory changes, and economic downturns. In some cases, small-cap and mid-cap companies may face a higher risk of bankruptcy or insolvency.
Why are these indices falling?
As you can see in the below chart, the Nifty Small Cap index almost doubled in less than a year, which is rare, right? Indexes don’t usually double in such a short span. You can also see a correction started happening in Feb’24. The most recent correction happened after SEBI raised concern over the bubble building in these two segments.
SEBI chief said that there is “froth” in small and mid-cap stocks owing to “off the charts” valuations in these market segments. And when the chief said so, the market had to react and we saw a sharp fall in the second week of March in these indices (up to 5%). There could be manipulation in small and midcap stocks and SEBI is willing to review norms that mandate small and mid-cap funds to invest 65% of their assets in these stocks.
Is the valuation really premium? Let us look at some numbers to answer this – BSE MidCap index trades at 25.6x of its one-year forward price-earnings compared to its 10-year average PE of 24.61x. So, yes it but the valuation is not super high. On the other hand, BSE Smallcap’s 1-year forward PE trades at 23.16x versus its 10-year average PE of 21.55x.
Will small and midcaps continue to fall?
If you look at historical corrections in small and midcap stocks/indices, the corrections are usually sharp. At present, a 15% correction has happened. However, these indices can correct up to 30% to 40%. For these reasons, investors may exercise caution in investing in stocks from these categories. If you plan to invest in them, please find quality names available at fair valuation and be prepared to ride the volatility.
What should investors do?
For higher returns, you need to invest in small and mid-cap stocks. But, you will not make profits unless you have a risk management system in place. You should be able to anticipate a fall before the fall. In the present situation, for most investors, it is not possible to find stocks for investment. And they cannot handle the risk on their own. The solution to this problem is using technology for investment – use AI for stock trading and investing. You can check Jarvis Invest and start your investment journey without the fear of market volatility since it takes care of everything.