Key factors to consider before investing in mid, smallcap stocks

Listed companies can be divided into three broad categories based on their market valuation or capitalisation. The firms listed on stock exchanges are divided into three categories as smallcap, midcap and largecap companies as per their valuation.

The market capitalisation of a company is calculated by multiplying the number of total outstanding shares by the current market price of a share.

As per the guidelines by market regulator Securities and Exchange Board of India (SEBI), the companies with a market capitalisation of more than ₹20,000 crore are classified under the largecap category. Those with a market value of ₹5,000 crore to ₹20,000 crore come under the midcap category while the entities with a market capitalisation of less than ₹5,000 crore are categorised as smallcap entities.

Let's now take a look at the important factors the investors should consider before investing in small and midcap stocks.

Portfolio diversification

Investors should focus on portfolio diversification as smallcap and midcap stocks represent companies of different sizes and market caps. Investors can avoid smallcap risks by diversifying their portfolio.

Assess risk tolerance

Investing in midcap and smallcap stocks carries moderate to high risk. These stocks tend to react sharply to market volatility as compared to their peers in the largecap category. You must assess your risk tolerance before embarking on an investment journey in the smallcap and midcap equity segments.

Market sensitivity

Smallcap stocks are more sensitive to market sentiments, and they tend to witness extreme swings. Midcaps are stable compared to smallcap stocks and offer a balanced exposure to investors. As an investor, you need to understand such risks and dynamics to make informed investment decisions.

Growth potential

Smallcap and midcap stocks have greater growth potential. Investing in mid and smallcap stocks can provide an opportunity to capitalize on early-stage businesses and earn good returns over a longer period of time. However, high return expectations also lead to mistakes of investing in wrong companies. It is advised to take help of a SEBI registered investment advisor before investing into small and midcaps stocks.

Smallcap stocks signify high risk, high reward

Smallcap stocks are attractive for investors looking to earn high returns on their investments. These stocks are from new companies with small market capitalisation. As a result, they are highly volatile and suitable for investors who can take high risks.

On the other hand, most midcap companies have the potential to earn high profits and pay dividends. Medium-sized companies have better access to capital and market borrowings than smallcap companies. This aids the future growth of midcap firms.

Liquidity aspect

Liquidity is a key aspect of any investment. Smallcap stocks lag in terms of liquidity when compared with midcap and large cap stocks. Smallcap stocks face more liquidity crunch compared to midcaps due to lower trading volumes. This may result in investors finding difficulty to sell shares. The lower liquidity may also lead to extreme swings and it could be challenging to execute trades at times.

Economic trends

Smallcaps and midcap stocks react differently to economic trends and sectoral performances. Smallcap stocks tend to benefit from emerging sectors and trends. On the other hand, midcaps exploit opportunities in expanding sectors.

Conclusion

You can invest in midcap and smallcap stocks by simply opening a demat account and registering for online trading with any of the brokerage firms. A thorough research and knowledge about the broader market trends in the midcap and smallcap segments would help you to pick suitable stocks.