Mid Cap Stocks

Generally "mid-cap" refers to stocks of companies having a market cap between $1.5 billion and $10 billion. These terms refer to a company's market capitalization, which is the number of outstanding shares times the stock's price.

Mid-cap stocks may have once been defined as large cap, but fell out of favor with investors. The thing to remember about market capitalization is that it is based on the price of one share of stock. Specific company stock returns, within a favorable market, can bump up from mid to large or dive in the other direction when conditions are reversed. Mid-cap stock performance usually falls somewhere in between the returns of their large- and small-cap counterparts.

Mid - Cap Stocks with high price momentum Shares of those companies with a market capitalization between Rs. 100 crores and Rs. 1000 crores and which have gained in-terms of price over a three - month period.

Small cap :       $250 Million to $2 Billion, approximately

Mid cap  :         $2 Billion to $10 Billion, approximately

Large cap:       $10 Billion and up, approximately

We have frequently heard about some companies being Large-cap (For e.g. Reliance, Infosys etc.) while others being Midcap or Small-cap companies. Wonder how they are classified? Let’s take a look at how the BSE classifies companies according to their market capitalization.

The 80-15-5 method:

BSE’s classifies companies according to their Market Capitalization by using the 80-15-5 method. Here’s how this method works:

• Arrange all the companies in descending order of their Market Capitalization.
• The group of companies from the top, which together contribute 80% of the total Market Capitalization are Large-cap Companies,
• The next group of companies contributing 15% (80-95%) of Market capitalization are Mid-cap companies, and
• The remaining companies which contribute 5% of Market Capitalization are Small-cap companies.

Thus, the Large-cap companies, Mid-cap companies and Small-cap companies contribute 80%, 15% and 5% of the total Market Capitalization of the market respectively. This is known as the 80-15-5 method. The number of small-cap companies is the highest followed by mid-cap and large-cap companies. Thus, a small proportion of the total number of companies (large-cap) contribute the major part (80%) of total market capitalization.

"Hard to believe papa was once a kid" goes an ad-line of a mutual fund scheme that invests in mid-cap stocks. Indeed it's hard to believe Infosys and Airtel were lesser-known companies 15 years ago. Today they are among the heavyweights of the country's two most well-known large-cap indices ' the Bombay Stock Exchange's Sensex and the National Stock Exchange's Nifty.

There are many such names which were once small or mid-cap companies but are now prominent large-cap companies that have generated very good returns over the years for investors.

EXPERT TIP: Defensive stocks help during market volatility

Fast growing economy like ours with a liberalised industrial and services sectors, the chances of finding small and mid-level companies with potential to becoming large corporations are much better than the developed economies like the US and Europe.

In this section, we try to zero in on some mid-cap companies with the potential to become large-cap companies in the next 5-10 years. We asked large brokerage houses to come out with their list of mid-cap companies that they believe have it in them to outperform others.

Large Cap Stocks

Sometimes, investment terminology is tossed around without really being explained…large-cap, small-cap, mid-cap - what exactly do they mean? The investment article published here is intended to help you get down to basics with a series of articles about the different asset classes.

First of all, let's define asset classes. They're the categories that your different investments fall into - basic ones include cash, bonds, large-cap stocks, small-cap stocks, and international stocks, though there are a number of other more specific permutations. Studies have shown that the key to successful investing is to spread your wealth among different asset classes.

Market capitalization is a term used on Wall Street that is extremely important. Although it is often heard on the nightly news and in financial textbooks, very few new investors know what market capitalization is or how it is calculated. It’s actually really easy and intuitive. After you read about the details of market cap, as it is often called for short, you’ll understand the concept and begin using it when putting together your own portfolio.

Put simply, market capitalization is the amount of money it would cost if you were to buy every single share of stock a company had issued at the current market price. For instance, The Coca-Cola Company has 2,317,441,658 shares of stock outstanding and the stock closed at $49.60 per share. If you wanted to buy every single share of Coca-Cola stock in the world, it would cost you 2,317,441,658 shares x $49.60 = $114,945,106,236.80. That’s just shy of $115 billion. On Wall Street, people would refer to Coca-Cola’s market capitalization as $115 billion.

Why is market capitalization such an important concept? It allows investors to understand the relative size of one company versus another. AutoZone, a retailer of auto parts, trades at $150.31 per share. Yet, the company’s market capitalization is only $8 billion. Despite having a stock price 3x higher than Coke, AutoZone is actually only 6.9% the size of the soft drink giant! There you can know How to Think About Share Price. In that article, you could have learn that it’s possible for a $300 stock to be cheaper than a $10 stock.

Traditionally, companies were divided into large-cap, mid-cap, and small-cap.[2] Market capitalization (or market cap) is the total value of the issued shares of a publicly traded company; it is equal to the share price times the number of shares outstanding.[2][3] Market capitalization ranks stocks into a number of distinct groups. This is important when considering an investment in a particular company.

To review, market capitalization (market cap) is a measure of the size and value of a company. To determine market cap, you simply multiply the number of the company's outstanding shares of stock by the market price of one share.

For example, let's say a company has 50,000,000 shares outstanding, and each share is currently selling for $50. The company's market cap would be 50,000,000 multiplied by $50, which equals $2.5 billion.

And why is market capitalization important? Because history has shown us that the stocks of companies with different market caps behave differently in terms of return and risk.

Because large-cap stocks have shown outstanding performance recently, you may have heard that investing in them would have been your best bet. But do large-cap stocks ALWAYS perform better than mid-cap and small-cap? Let's take a look.

Each rank has certain stereotypical features that you can look for in the stock under consideration. Mid cap stocks are more risky than large cap stocks and less risky than small cap stocks. As outstanding stock is bought and sold in public markets, capitalization could be used as a proxy for the public opinion of a company's net worth and is a determining factor in some forms of stock valuation.

The terms mega-cap and micro-cap have also since come into common use,[6][7] and nano-cap is sometimes heard. Different numbers are used by different indexes;[8] there is no official definition of, or full consensus agreement about, the exact cutoff values. The cutoffs may be defined as percentiles rather than in nominal dollars. The definitions expressed in nominal dollars need to be adjusted over the decades due to inflation, population change, and overall market valuation (for example, $1 billion was a large market cap in 1950, but it is not very large now), and they may be different for different countries. A rule of thumb may look like:

• Mega-cap: Over $200 billion
• Large-cap: Over $10 billion
• Mid-cap: $2 billion–$10 billion
• Small-cap: $250 million–$2 billion
• Micro-cap: $50 million-$250 million
• Nano-cap: Below $50 million

The total capitalization of stock markets or economic regions may be compared to other economic indicators. The total market capitalization of all publicly traded companies in the world was US$51.2 trillion in January 2007[4] and rose as high as US$57.5 trillion in May 2008[5] before dropping below US$50 trillion in August 2008 and slightly above US$40 trillion in September 2008.[5]
 
Now that we understand what market cap means, let's talk about the performance of different-sized-market cap stocks. We know that over the past few years, large-cap stocks have performed very well. For the ten years ended June 30, 1999, large-cap stocks, as measured by the S&P 500, returned an average of 18.78% per year. Mid-cap stocks, as measured by the S&P 400, returned an average of 17.87% per year for the same period. And small-cap stocks, as measured by the Russell 2000, had average annual returns of 12.39% for the same time period. So, it's easy to see that in the last decade, large-cap stocks performed the best out of these three groups.

Generally, risk of company failure decreases as the company increases in size. However, a mid cap stock also has better potential for growth than a large cap company. A very large company may have completely saturated its market, while a mid-sized company may have room to grow. So when considering an investment, you are basically trying to decide if the stock in question has the potential to grow into a large cap stock. If you are right and make the investment, you will have a successful investment.
   
The Shortcomings of Market Capitalization

There are some shortcomings to using market capitalization as a guide to a company’s size. The biggest is that market capitalization does not factor into consideration a company’s debt. In other words, in addition to having $115 billion in stock market value, Coca-Cola has $20 billion in debt. If you were to buy every share of Coke’s stock, you would own the company but still be responsible for the company’s $20 billion in debt. Thus, your “true” purchase price would be $115 billion + $20 billion = $135 billion. This figure is known as enterprise value and I explained everything you need to know about it in the article Enterprise Value – Determining the Takeover Value of a Company. There are actually some other factors that determine the difference between market capitalization and enterprise value so if you’re interested in the details, it would be worth your time to click over to those articles and take a few moments to read them.

Using Market Capitalization to Build a Portfolio
A lot professional investors divide their portfolio by market capitalization size. This approach, they believe, allows them to take advantage of the fact that smaller companies have historically grown faster but larger companies have more stability and pay fatter dividends.

Here is a breakdown of the type of market capitalization categories you are likely to see referenced when you begin investing:

• Micro Cap: The term micro cap refers to a company with a market capitalization of less than $300 million.
• Small Cap: The term small cap refers to a company with a market capitalization of $300 million to $2 billion.
• Mid Cap: The term mid cap refers to a company with a market capitalization of $2 billion to $10 billion.
• Large Cap: The term large cap refers to a company with a market capitalization of $10 billion to $50 billion.
• Mega Cap: The term mega cap refers to a company with a market capitalization of $50 billion or more.

Fundamental Analysis - Weaknesses

Weaknesses of Fundamental Analysis

Time Constraints

Fundamental analysis may offer excellent insights, but it can be extraordinarily time-consuming. Time-consuming models often produce valuations that are contradictory to the current price prevailing on Wall Street. 

When this happens, the analyst basically claims that the whole street has got it wrong. This is not to say that there are not misunderstood companies out there, but it is quite brash to imply that the market price, and hence Wall Street, is wrong.

Industry / Company Specific

Valuation techniques vary depending on the industry group and specifics of each company. For this reason, a different technique and model is required for different industries and different companies. This can get quite time-consuming, which can limit the amount of research that can be performed. A subscription-based model may work great for an Internet Service Provider (ISP), but is not likely to be the best model to value an oil company.

Subjectivity

Fair value is based on assumptions. Any changes to growth or multiplier assumptions can greatly alter the ultimate valuation. Fundamental analysts are generally aware of this and use sensitivity analysis to present a base-case valuation, an average-case valuation and a worst-case valuation. However, even on a worst-case valuation, most models are almost always bullish, the only question is how much so. The chart below shows how stubbornly bullish many fundamental analysts can be.

Analyst Bias

The majority of the information that goes into the analysis comes from the company itself. Companies employ investor relations managers specifically to handle the analyst community and release information. As Mark Twain said, "there are lies, damn lies, and statistics." When it comes to massaging the data or spinning the announcement, CFOs and investor relations managers are professionals. 

Only buy-side analysts tend to venture past the company statistics. Buy-side analysts work for mutual funds and money managers. They read the reports written by the sell-side analysts who work for the big brokers (CIBC, Merrill Lynch, Robertson Stephens, CS First Boston, Paine Weber, DLJ to name a few). These brokers are also involved in underwriting and investment banking for the companies. 

Even though there are restrictions in place to prevent a conflict of interest, brokers have an ongoing relationship with the company under analysis. When reading these reports, it is important to take into consideration any biases a sell-side analyst may have. 

The buy-side analyst, on the other hand, is analyzing the company purely from an investment standpoint for a portfolio manager. If there is a relationship with the company, it is usually on different terms. In some cases this may be as a large shareholder.

Definition of Fair Value

When market valuations extend beyond historical norms, there is pressure to adjust growth and multiplier assumptions to compensate. If Wall Street values a stock at 50 times earnings and the current assumption is 30 times, the analyst would be pressured to revise this assumption higher. 

There is an old Wall Street adage: the value of any asset (stock) is only what someone is willing to pay for it (current price). Just as stock prices fluctuate, so too do growth and multiplier assumptions. Are we to believe Wall Street and the stock price or the analyst and market assumptions?

It used to be that free cash flow or earnings were used with a multiplier to arrive at a fair value. In 1999, the S&P 500 typically sold for 28 times free cash flow. However, because so many companies were and are losing money, it has become popular to value a business as a multiple of its revenues. This would seem to be OK, except that the multiple was higher than the PE of many stocks! Some companies were considered bargains at 30 times revenues.

Conclusions

Fundamental analysis can be valuable, but it should be approached with caution. If you are reading research written by a sell-side analyst, it is important to be familiar with the analyst behind the report. We all have personal biases, and every analyst has some sort of bias. There is nothing wrong with this, and the research can still be of great value. Learn what the ratings mean and the track record of an analyst before jumping off the deep end. Corporate statements and press releases offer good information, but they should be read with a healthy degree of scepticism to separate the facts from the spin. Press releases don't happen by accident; they are an important PR tool for companies. Investors should become skilled readers to weed out the important information and ignore the hype. 

Fundamental Analysis - Strengths

Strengths of Fundamental Analysis

Long-term Trends 
Fundamental analysis is good for long-term investments based on very long-term trends. The ability to identify and predict long-term economic, demographic, technological or consumer trends can benefit patient investors who pick the right industry groups or companies. 

Value Spotting

Sound fundamental analysis will help identify companies that represent a good value. Some of the most legendary investors think long-term and value. Graham and Dodd, Warren Buffett and John Neff are seen as the champions of value investing. Fundamental analysis can help uncover companies with valuable assets, a strong balance sheet, stable earnings, and staying power.

Business Acumen

One of the most obvious, but less tangible, rewards of fundamental analysis is the development of a thorough understanding of the business. After such painstaking research and analysis, an investor will be familiar with the key revenue and profit drivers behind a company. Earnings and earnings expectations can be potent drivers of equity prices. Even some technicians will agree to that. A good understanding can help investors avoid companies that are prone to shortfalls and identify those that continue to deliver.  

In addition to understanding the business, fundamental analysis allows investors to develop an understanding of the key value drivers and companies within an industry. A stock's price is heavily influenced by its industry group. By studying these groups, investors can better position themselves to identify opportunities that are 

  high-risk (tech),
  low-risk (utilities),
  growth oriented (computer),
  value driven (oil),
  non-cyclical (consumer staples),
  cyclical (transportation) or
  income-oriented (high yield).

Knowing Who's Who

Stocks move as a group. By understanding a company's business, investors can better position themselves to categorize stocks within their relevant industry group. Business can change rapidly and with it the revenue mix of a company. This happened to many of the pure Internet retailers, which were not really Internet companies, but plain retailers. Knowing a company's business and being able to place it in a group can make a huge difference in relative valuations.

  

SENSEX CALCULATION

SENSEX, first compiled in 1986, was calculated on a 'Market Capitalization-Weighted' methodology of 30 component stocks representing large, well-established and financially sound companies across key sectors.  

SENSEX is calculated using the 'Free-float Market Capitalization' methodology, wherein, the level of index at any point of time reflects the free-float market value of 30 component stocks relative to a base period.  

SENSEX today is widely reported in both domestic and international markets through print as well as electronic media. It is scientifically designed and is based on globally accepted construction and review methodology.

The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization.

The base period of SENSEX is 1978-79 and the base value is 100 index points. This is often indicated by the notation 1978-79=100. Since September 1, 2003, SENSEX is being calculated on a free-float market capitalization methodology. The 'free-float market capitalization-weighted' methodology is a widely followed index construction methodology on which majority of global equity indices are based; all major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the free-float methodology.

The calculation of SENSEX involves dividing the free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions, replacement of scrips etc. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate SENSEX on a continuous basis.

The growth of the equity market in India has been phenomenal in the present decade. Right from early nineties, the stock market witnessed heightened activity in terms of various bull and bear runs. In the late nineties, the Indian market witnessed a huge frenzy in the 'TMT' sectors. More recently, real estate caught the fancy of the investors. SENSEX has captured all these happenings in the most judicious manner. One can identify the booms and busts of the Indian equity market through SENSEX. As the oldest index in the country, it provides the time series data over a fairly long period of time (from 1979 onwards). Small wonder, the SENSEX has become one of the most prominent brands in the country.

STOCKS SELECTION CRITERIA :-

The general guidelines for selection of constituents in SENSEX are as follows:

·                                 Equities of companies listed on Bombay Stock Exchange Ltd. (excluding companies classified in Z group, listed mutual funds, scrips suspended on the last day of the month prior to review date, scrips objected by the Surveillance department of the Exchange and those that are traded under permitted category) shall be considered eligible.

·                                 Listing History: The scrip should have a listing history of at least three months at BSE. An exception may be granted to one month, if the average free-float market capitalization of a newly listed company ranks in the top 10 of all companies listed at BSE. In the event that a company is listed on account of a merger / demerger / amalgamation, a minimum listing history is not required.

·                                 The scrip should have been traded on each and every trading day in the last three months at BSE. Exceptions can be made for extreme reasons like scrip suspension etc.

·                                 Companies that have reported revenue in the latest four quarters from its core activity are considered eligible.

·                                 From the list of constituents selected through Steps 1-4, the top 75 companies based on free-float market capitalisation (avg. 3 months) are selected as well as any additional companies that are in the top 75 based on full market capitalization (avg. 3 months).

·                                 The filtered list of constituents selected through Step 5 (which can be greater than 75 companies) is then ranked on absolute turnover (avg. 3 months).

·                                 Any company in the filtered, sorted list created in Step 6 that has Cumulative Turnover of >98%, are excluded, so long as the remaining list has more than 30 scrips.

·                                 The filtered list calculated in Step 7 is then sorted by free float market capitalization. Any company having a weight within this filtered constituent list of <0 .50="" be="" excluded.="" o:p="" shall="">

·                                 All remaining companies will be sorted on sector and sub-sorted in the descending order of rank on free-float market capitalization.

·                                 Industry/Sector Representation: Scrip selection will generally attempt to maintain index sectoral weights that are broadly in-line with the overall market.

·                                 Track Record: In the opinion of the BSE Index Committee, all companies included within the SENSEX should have an acceptable track record.

FREE FLOAT METHODOLOGY :-

Free-float methodology refers to an index construction methodology that takes into consideration only the free-float market capitalization of a company for the purpose of index calculation and assigning weight to stocks in the index. Free-float market capitalization takes into consideration only those shares issued by the company that are readily available for trading in the market. It generally excludes promoters' holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course. In other words, the market capitalization of each company in a free-float index is reduced to the extent of its readily available shares in the market.

Subsequently all BSE indices with the exception of BSE-PSU index have adopted the free-float methodology.

DEFINITION OF FREE FLOAT :-

Shareholding of investors that would not, in the normal course come into the open market for trading are treated as 'Controlling/ Strategic Holdings' and hence not included in free-float. Specifically, the following categories of holding are generally excluded from the definition of Free-float:

·                                 Shares held by founders/directors/ acquirers which has control element

·                                 Shares held by persons/ bodies with 'Controlling Interest'

·                                 Shares held by Government as promoter/acquirer

·                                 Holdings through the FDI Route

·                                 Strategic stakes by private corporate bodies/ individuals

·                                 Equity held by associate/group companies (cross-holdings)

·                                 Equity held by Employee Welfare Trusts

·                                 Locked-in shares and shares which would not be sold in the open market in normal course.

MAJOR ADVANTAGES OF FREE FLOAT METHODOLOGY :-

·                                 A Free-float index reflects the market trends more rationally as it takes into consideration only those shares that are available for trading in the market.

·                                 Free-float Methodology makes the index more broad-based by reducing the concentration of top few companies in Index.

·                                 A Free-float index aids both active and passive investing styles. It aids active managers by enabling them to benchmark their fund returns vis-� -vis an investible index. This enables an apple-to-apple comparison thereby facilitating better evaluation of performance of active managers. Being a perfectly replicable portfolio of stocks, a Free-float adjusted index is best suited for the passive managers as it enables them to track the index with the least tracking error.

·                                 Free-float Methodology improves index flexibility in terms of including any stock from the universe of listed stocks. This improves market coverage and sector coverage of the index. For example, under a Full-market capitalization methodology, companies with large market capitalization and low free-float cannot generally be included in the Index because they tend to distort the index by having an undue influence on the index movement. However, under the Free-float Methodology, since only the free-float market capitalization of each company is considered for index calculation, it becomes possible to include such closely-held companies in the index while at the same time preventing their undue influence on the index movement.

·                                 Globally, the Free-float Methodology of index construction is considered to be an industry best practice and all major index providers like MSCI, FTSE, S&P and STOXX have adopted the same. MSCI, a leading global index provider, shifted all its indices to the Free-float Methodology in 2002. The MSCI India Standard Index, which is followed by Foreign Institutional Investors (FIIs) to track Indian equities, is also based on the Free-float Methodology. NASDAQ-100, the underlying index to the famous Exchange Traded Fund (ETF) - QQQ is based on the Free-float Methodology.