(A slightly shorter version in today's Business Standard)
FROM MIDCAP TO MUDCAP
Recently, SEBI has identified a list of around 2000 companies, which have been identified as “illiquid” stocks. It is a mix of good, bad and great companies. All of them would fall under either “mid cap” or ‘small cap’ stocks and are generally the focus of attention from media, analysts and punters. In good times, the prices of these stocks exhibit a strong upward move. Alas, when selling comes, the bottom seems to fall out of these stocks. Many of them can lose ninety percent of their price! And these kind of wild movements are possible without significant change in the underlying company fundamentals. Most investors prefer this universe since this is where they find their multi-baggers. One can hardly find one from the NIFTY or the SENSEX companies, which are over researched and widely tracked.
This is clearly a structural issue. The FII’s and the domestic institutions are engaged in playing the large caps and the small caps are at the mercy of price fixers and manipulators. The breadth of participation has been gradually thinning, as the retail numbers of investors in secondary markets keep declining. It is very evident that our markets are driven by the FII’s and not by anyone else. Their buying and selling has been the prime engine behind our markets. So, our market is a kind of a one-way street. If the FII’s are selling, the market dips fast and vice versa. The large cap stocks do not fall as hard as the small counters, which seem to generally hit circuits in either direction.
Over the last five odd quarters, the FII buying has helped the markets to recover from its lows of sub 10,000. Suddenly, at some point the euphoria of India seems to have hit a blimp. Our inflation is clearly a structural one and unless the supply is improved, it will persist. So, a tempering of growth plus a slowdown in corporate earnings means that the FII’s have perhaps taken a pause. The Indian market needs buyers every day. On days a buyer does not come, the market falls. We simply do not have a category other than the FII’s and some insurance money that comes in by the selling of ULIP’s.
Small and medium sized companies are a minefield for the investor. Unless there is active pumping and dumping, I cannot fathom why most stocks from this bucket should have any investor interest at all. Clearly, the risks are very high. However, one can see opportunities if willing to take high risks. Interestingly, one can see that most MNC counters held on in this corrective downward movement (which may not be over). Most mid cap companies have huge management risks and personally, this is the real speculative component of the market. No one can bet which promoter will show how much profit any given year. If the investors have a compulsion to buy mid cap stocks, it is safer to put it in to a mid cap fund. Even in mid caps, it is still a play on growth and not on value. Prices have not fallen to that extent. Do not get taken in by steep price falls and assume that past high prices will happen again. You have time to do your homework.
The prime movers of the midcap stocks are the fund managers, who identify these stocks and actively invest and trade in them to generate returns above the benchmark. In a bull market this strategy works, given the poor liquidity of the mid cap counters. This is because supply comes from sources close to the promoter or from domestic institutions. The counters by themselves have poor trading volumes. So, once a fund buys a block, then an active follow up by buying on the market will keep the prices stable to high. Since there is not much retail participation, the downside is kind of protected in a rising market. In a falling market, the fund manager tries to lock in to his profits and tries to dump the mid cap stocks. Alas, the only class of buyers have turned sellers. The stock prices fall steeply. Retail investors who got in to these stocks, get hit badly.
This universe is a high risk high reward universe. If you are lucky to get in just before the institutional investor gets in, you can get a great return. On the other hand, when the institutional guys get out, the prices of midcap shares crash. This could be a buying opportunity, but the timing is difficult to catch. Buying here means having to wait it out till the next round of bullish buyers get back in to the market.