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Mid-Cap Stocks Have To Be Carefully Selected

Monday, November 28, 2011

K Jayraman
is Research Associate, Bonanza Portfolio

Companies in the mid-cap segment represent various sectors which have a track record of more than 3 years and have positive net worth. There are selected companies which have shown phenomenal growth in the recent 5 years and have substantially outperformed the market. For example, Titan industries, the company has developed a big brand and created a wide network of new show room all over India and commands an excellent premium for their products. The adjusted share price has grown from Rs 20 levels in 2006 to a high of Rs 237 in September 2011 and even now trading at Rs 190. The second would be Yes Bank, in the private banking sector which has exceedingly performed with a CAGR of more than 25% in the last 3 years, increasing its branches and productivity year on year. The share price of this bank has gone up from Rs 40 in March 2009 to a high of Rs 382 in November 2010 and even now trading at Rs 277.

These are companies which have future potential to become large-cap companies by their strategic growth plans, size, innovative products and services and high productivity leading to improved bottom lines.

Normally the volatility and movement in prices of mid-cap stocks and index is relatively higher as compared to Nifty stock and Nifty Index. In the last one year the Nifty index has declined from 6338 in November 2010 to 4639 in November 2011 which is approximately 27%. In the same period Nifty Mid-cap representing 50 stocks has come down from 3290 to 1833 which is a fall of approx 44%. Also CNX Mid-cap representing 100 stocks has come down from 9853 to 6398 which is fall of 35%. Therefore in mid-cap stocks, the good is well rewarded and the bad is severely punished.

Even though the mid-cap index has declined by 40% (approx) in the last one year, Infra companies have declined between 65 to 75%. For example the share of HDIL (Housing Development Infrastructure Ltd) has declined from a high of Rs 266 to Rs 62 in the last one year registering a fall of 76%. Similarly other mid-cap infra companies like IVRCL, Unitech, HCC and Punj Lloyd being in the same sector has undergone severe correction between 65% to 75% in the last one year. This is due to the fact that these companies have long gestation periods and there are delays in execution and completion of projects on time. The rising interest rates have put severe pressure on the profitability of these companies.

Also they are cash starved for their working capital needs. Investors should carefully monitor these developments and accordingly avoid investing in these sectors. Another example is EDUCOM which has fallen from a high of Rs 654 to Rs 162 in the last one year registering a fall of 68%. This is due to the fact that the investors have lost confidence in the sustainability and sequential growth of this company. Moreover the company had other accounting disclosure issues and recently had searches and enquiries conducted by revenue authorities.

In other words the investor has to be twice cautious in choosing to invest on mid-caps and do a thorough analysis about the price, values and growth potential of the stock. Also he should have a good knowledge about the industry, management and track record of these companies.

Now let us analyse the opportunities that exist in mid-cap stocks in today’s market condition. One thing that is clear in the market is that the market has substantially corrected in mid-cap stocks up to 40 to 45% in the last one year. There are potential scrips with attractive valuations for a holding period of 12 to 18 months which can reward the investors phenomenally. United Phosphorus for example has come down from a high of Rs 216 to Rs 112 in the last one year and currently trading at Rs130. This is a chemical company with global reach and consistent earnings. This may be added to the portfolio at current price.

Also the share price of JSW Steel has come down from a high of Rs 1345 to Rs 479 registering a fall of 64% in one year and currently trading at Rs576. The company recently had issues on iron ore procurement and therefore the share prices were beaten out of shape. The company belongs to Jindal group who are very aggressive in their business models and this mid-cap stock could appreciate at least 30 to 40% in the next one year.

Similarly India Cements have fallen from a high of Rs 143 to Rs 62 in the last one year and currently trading at Rs 72. The recent quarterly results of the company have shown excellent turnaround and the share has got a potential to double in the next two years.

Overall mid-cap stocks are like double edged sword and will have to be carefully handled knowing the market conditions, the stock, the industry, the price , the track record, the management etc. However if such care is taken mid-cap stocks will out beat and give phenomenal returns in the market and many  mid-cap of the previous year are already shinning as large cap shares today.

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