Buying Stocks - Golden Rules For Buying Mid Cap & Small Cap Stocks

Investors wanting to get best returns out of their investments in stocks always want to buy stocks falling in mid cap and small cap category. Here are few rules to spot best mid cap stocks to buy.

Growth Rate
Before selecting mid cap stocks, an investor must examine the growth rate. Growth rates can come through either financial engineering or operational expertise. An investor has to take caution if there is growth through financial engineering that includes inflated profit levels through income from other sources. Experts suggest, a CAGR of 30-40 per cent through operational growth in last 5 years in mid caps makes a strong case for buying.

“When an investor buys a midcap stock, he takes more risk than in large cap stocks. This risk has to be compensated by good returns,” said Amitabh Chakraborty, president - equity, Religare Capital Markets; who advises investors to get into mid cap stocks not with a target price but a target return in mind. Once he achieves that return, he should sell stocks.

Religare’s Chakraborty suggests that target return should be at least 50 per cent within a year. Further, an investor should also examine whether the current pace of growth is sustainable in the next 3-4 years through the outlook of the business vertical.

Promoters’ credibility is another important aspect to look at. Promoters’ holding in a mid cap company should be sizable (at least 25-50 per cent) enough which underscores their accountability for the company.

Look at the history of company’s promoter’s holding. If any company dilutes its stake at a higher price followed by buying warrants at a lower price, it does not augur well for investors.

Low P/E Ratio
Mid cap stocks with low PE ratio is recommended while those with capital intensive bearings should be avoided. “A mid cap company with huge forex losses and outstanding dues is not worth investing,” added Yogesh Kalwani, head - advisory, BNP Paribas Investment Services, who feels, as and when credit flows come back, 25 per cent allocation mid caps is reasonable for retail investors.

The BSE Midcap Index has appreciated by 17 per cent over the past one month, while the 30-share benchmark - Sensex has gained just over 17 per cent during the same period. Correction in the market is around the corner. The moment it happens, one should start investing in right kind of mid caps.

SMC’s Jain suggests investors to make a basket of mid cap stocks and keep close watch on their movement next one month after investment. Explaining an investment strategy, Jain epitomized, “If you buy 10 mid cap stocks and 5 of them performs good after one month, get out of two worst performing stocks and invest the proceeds in some other mid cap stocks.”

“Buy mid cap stocks at 20 per cent discount from their current level after judging their credentials. A correction will cater to that opportunity,” concluded Chakraborty.

Some of the mid caps stocks to buy at this time as suggested by Religare are Jain Irrigation, Voltas, GVK Power, Bata India, IRB Infrastructure, HDIL etc.