MID CAP Funds

If the number of shares in a company is multiplied by its current price, the result is market capitalisation. Based on this, companies are classified as large-cap, mid-cap and small-cap.

Blue chips are the largest companies in their sectors; the ones with the largest market cap.

If you can identify tomorrow's blue chips today, you could make a pile of money.

That's because these stocks, with smaller market caps, are usually priced low, since investors have not yet discovered their potential.

In the mid-cap segment, you may find such companies.

In fact, big investors, like mutual funds and Foreign Institutional Investors, have started investing in mid-caps in the recent past, because the price of large caps has increased substantially.

That has led to a big rally in small and mid-caps, with their prices climbing upwards steadily.

The mid-cap segment of the stock market is, thus, being increasingly perceived as an attractive investment segment with high growth potential.

However, there are certain things you must know about mid-cap stocks before you invest in them directly or via a mid-cap mutual fund.

High volatility

These stocks tend to be very volatile.

Volatility is the rate of change in the price of the shares over a given time. The greater the price fluctuation, the higher the volatility.

Historically, mid-cap stocks have displayed the tendency to rise more than large-caps in a booming market (like the one you are seeing now) and plunge to more depths when the markets dip.

While mid-caps may be going great guns at the moment, their historic record shows that they can fall like a pack of cards in bad times.

Liquidity constraints

Mid-cap stocks have a smaller capital base (number of shares) and suffer from low liquidity.

Liquidity refers to how easily the shares can be bought or sold in the market without significant loss of value.

Mid-cap funds have to then find quality mid-cap stocks to invest in. And, if they do not, then a chunk of their portfolio (total amount with them for investment) is left in idle cash.

If, however, they succeed in investing the entire portfolio in few mid-cap stocks by taking excessive exposure to each of them, then they might find it difficult to sell the holdings later, given the liquidity constraints.

All mid-caps are not great buys

Mid-caps are characterised by lower market capitalisation and limited liquidity.

When such stocks witness a lot of buying, as they have in the recent past, their prices shoot up. Irrespective of whether or not their fundamentals are strong and in place or whether they are intrinsically sound companies.

Picking up this rising trend, investors are pumping in more and more money into mid-cap stocks, further driving up the prices.

It has now turned into a vicious cycles or fresh money boosting up prices, which further attracts some more money.

Should you invest in a mid-cap fund?

If you have already invested in a diversified equity fund (fund that invest in the shares of various companies of various sectors), then you should know that even they have notably increased their exposure to mid-cap stocks.

So you are actually getting the mid-cap benefit even in a normal diversified equity fund

But, if you are willing to take the risk, then you could consider a mid-cap fund.

But do note, each fund house defines a mid-cap stock in a different way. Since there is no standardised definition of a mid-cap stock, each mutual fund will have its own. So what one fund house may consider a mid-cap, another may not.

It is undeniable that the spectacular performance of the mid-cap stocks has been nothing less than breath-taking.

You can make money. In fact lots of money. But how much you invest in mid-caps depends on how much of risk you are willing to take.

Remember, all mid-caps are not tomorrow's large-caps.

Illustration: Dominic Xavier

1. You own a part of the business

When you invest in stocks, you do not invest in the market (despite what you think). You invest in the equity shares of a company. That makes you a shareholder; you now own a small part of that business without having to go to work there.

The good news is, since you own part of the company, you are entitled to a share in its profits.

The bad news is that you are also expected to bear the losses, if any.

That is why investing in shares is risky. If the company does well, you benefit. If it does not, you lose. There are no guarantees whatsoever.

2. In the short-run, the price of the share can wildly fluctuate

Let's say the company fixes the price of each share at Rs 10. This is called the face value of the share.

When the share is traded in the stock market, this value may go up or down depending on supply of and demand for the stock.

If everyone wants to buy the shares, the price will go up. If nobody wants to buy the shares, and many want to sell them, the price will fall.

The value of a share in the market at any point of time is called the 'price of the share' or the 'market value of a stock'.

A share with a face value of Rs 10 may be quoted at Rs 55 (higher than the face value) or even Rs 9 (lower than the face value).

So you might have paid Rs 15 for a share which is now quoting at Rs 12. Don't panic and sell. If it is a good company, the share price will eventually rise.

The prices will get influenced by the market sentiment and the general direction of the market. As a result, you may see short-term slumps.

3. Always invest for the long-term

The best way to make money is to buy low and sell high. This means you should buy the share when the price is low and sell it when it is high.

That is why you must buy in a bear market. This is a term used to describe the sentiment of the stock market when it is low and the prices of shares have generally fallen. The best time to sell is in a bull market, when the sentiment is high and the prices of shares are rising.

But it is very difficult to time the market. In fact, no one can do it. If we could, we would all be millionaires, wouldn't we?

That is why, when you invest in the market, it is best to invest for the long-term. Hold on to your shares for a few years before you think of selling them.

Companies increase their sales and book higher profits over the years. This will eventually reflect in the share price, so ignore the short-term slumps.

Once you decide that you are in for the long haul, you can ride over the bear and bull runs with no stress at all. Over time, the price of your shares will appreciate.

If you are getting a good price for your stock, keep selling small amounts at regular intervals. Keep booking profits.

4. Decide how much you want to invest

Always remember one basic rule in finance -- if something gives you higher returns, that's usually because it carries a greater risk.

That's the reason why not-so-good companies will pay you a higher rate of interest for your deposits.

The same reasoning goes for stocks too -- they give higher returns than, say, bank fixed deposits because they are more risky. So the amount of money you invest in the market depends on your capacity to bear the risk.

If you are young with a steady job, you can invest a larger proportion of your income in the stock market than, say your parents who are close to retirement. If you have a lot of debt to repay, avoid putting too much of your money in stocks.

It's best to decide how much of your savings you will allocate to stocks, and stick to that plan. Don't get swayed by how much your friend is investing.

5. Don't rely solely on 'good advice'

A smart investor should never invest buy shares of companies he doesn't know much about. Relying on 'advice' from friends is not always a great idea. Do some groundwork yourself.

It doesn't matter who is buying the stock or who is recommending it. Steer clear of such ways of making a fast buck. These tips will land you in a soup.

When you hear of a 'hot tip', dig further.

Take a look at the company's profit and loss statement, which would have been audited by chartered accountants. There is a wealth of information here. Do some basic calculations on your own. The Earnings Per Share (net profit/ number of shares) and Price/Earnings ratio (market price/ EPS) should give you a fair understanding. A mutual fund manager will research many companies before investing in their shares. This way, you can participate in the stock market even as you leave the research to professionals.

Illustration: Dominic Xavier

Five rules to investing.

1. Invest in learning

Before you invest in stocks, get your hands on some good reading material. Read the financial dailies and magazines. Surf the Internet and watch CNBC channel.

I spend at least four to five hours daily just reading, listening to the news, reading e-mails and research reports from various brokers. But, hey, that is my job!

2. Look behind the scenes

Look behind what is apparent. It is like looking at a James Bond movie and thinking the hero leads the show, ignoring the doubles, stuntmen, and the entire production and camera crew that go into this movie.

When the talk is about a real estate boom or a retail boom, with malls and department stores sprouting all over the country, look behind the scenes. This will definitely impact the ceramics industry, sanitary suppliers and the glass industry, to name a few. Look for companies in these areas.

Similarly, when talking about textile and auto part exports, look at ports, shipping companies, packaging companies and logistics companies.

When the buzz is about medicines, think about the companies that prepare capsules, like Bharti, Natural Caps and, now, India Gelatin, who makes the gelatin required for the capsules.

3. Dividend is the key

If a company pays dividend regularly, it is a sign that it has a good balance sheet. Look for such finds, and check the dividend history over the last five years. Of these, pick the ones that have a higher dividend yield as compared to a one or two-year bank fixed deposit.

Buy them and hold on to them. Remember, every dog has its day. Soon, this company will be noticed.

When I bought Bhartiya International for a little over Rs 20 in 2001, it was giving a dividend yield of 6% to 8%. Now, I can safely take a 300% appreciation if I sell the shares.

Ditto in the case of other companies like Rasoi, Srinivasa Hatcheries [Garware Wall, Cosmo Films Nilkamal and Raj Plastics.

4. Welcome trouble

No one wants to invest in 'trouble' companies. But, sometimes, they make for great opportunities.

The key is to locate the source of the problem. And then judge whether it is a one-time occurence or, possibly, a lifetime one.

For instance, not getting gas for production is not a lifetime trouble for Regency Ceramics It can be resolved quickly, enabling the company to bounce back.

5. Invest in Penny Stocks

If you like to play penny stocks, don't invest blindly. These are stocks that are really cheap, but risky, too.

Be selective. Look at the sector as a whole and see by how much the price of the leading stocks have moved. Now look for penny stocks in that sector which are yet to climb upward.

But, again, follow some rules. The companies must have good earnings (revenue).

Find out why they are still not the market favourites. Do they have low profit margins? Are their profits being cut because they are paying back loans at a high interest rate? Do they have a lot of loans to service?

Over time, the profit margins will increase if there is a price hike. Or once their debt is cleared, their profits will shoot up.

Take, for instance, steel and cement stocks.

I bought Jindal Vijaynagar & Steel (now Jindal Steels) on September 12, 2001, which was available at around Rs 2.50 and Rs 3.50. I sold at the start of 2005 for a little more than Rs 15.

On the same day, Mangalam Cement was available in the Rs 3.50 to Rs 5.50 range, and is now around Rs 75.

I picked up JCT (textile stock) in 2002 for around Rs 3 and the stock is currently trading at around Rs 15.

These three stocks are classic examples of well managed companies incurring losses due to high interest charges and low profit margins.

Once these sectors bounced back, they began to reduce their debt by refinancing at lower interest rates