I recently bumped into Sean, an old friend of mine. Since we met after long, we decided to chat over a coffee and started discussing a variety of subjects, markets being one of them. He seemed to be deeply disturbed by the recent meltdown in mid/small cap stocks and had apparently booked out of most of his holdings with a huge haircut. “Investing in mid caps doesn’t pay in the long run. The strategy is clear. I shall henceforth invest only in the largest company of any sector that i identify. I’ve realised that these stocks tend to outperform and give the best returns over a long period of time. One cant go really wrong with this” said Sean.
I smiled. “This is not the first time i’ve come across such a view. This is amongst the most typical thoughts, by most investors, during corrective phases of the market. One bounce in the market is all that it takes for many of us to change this well-thought-of strategy. ”
“Don’t get me wrong here” i said. “I’m not advocating investments only in mid/small caps. While large cap stocks definitely prove much more resilient (comparatively) during tough times and tend to provide some safety net, there are several stocks down the market cap curve that have displayed similar characteristics and delivered outstanding returns as well, over a longer period of time. Proper due diligence, before taking positions, would help you identify and stick to such investments.” However, clouded by his most recent experience, Sean seemed to disagree with my opinion.
To verify my own claims and back it up with data, I decided to do some number crunching. Sector/stock performance, over a period of last 10 years (March 2009 – June 2018), was collated for this purpose. This period seemed appropriate because of the steep correction in mid cap stocks/indices witnessed in Mar ’09, akin to what we are witnessing currently.
Hereunder are some of the observations from our compilation. The 1st column ranks the companies (in our sample set) based on their revenues during 2009. The last column ranks their resp. stock returns. We rank these 2 parameters to check if the industry leaders necessarily delivered the best return, during the 10-year period. Their sales and profit CAGRs have also been listed to determine if the stellar stock performance tracked their financial performance as well and vice versa.
The best return in the IT sector was provided by Zensar Technologies, which is a significantly smaller player compared to the industry giants. It managed to deliver a 46% CAGR over the period.
The best returns in the cement sector was provided by Shree Cements and Ramco Cements, which were half the size of the industry leaders then and even smaller today courtesy the consolidation witnessed by the industry during this phase.
Aurobindo and Torrent Pharma, again significantly smaller than the industry leaders, delivered much superior returns than the industry leaders. Their returns outstripped the leaders by a significant margin.
The revelations are no different in this sector as well. Britannia and Godrej Consumer, ranked much smaller on the revenues front then, deliver much superior returns over a 10 year period.
Auto Ancillary sector
Industry leaders in this sector, MRF & Sundaram Clayton, rank equally high in terms of their stock returns, over the 10 year period. Interestingly, much smaller players like Balkrishna Inds and Minda Inds, also deliver returns comparable to those of the industry leaders.
Eicher Motors & Force Motors, the smallest players in our sample set, deliver the highest returns; 73% & 50% CAGR respectively, far outstripping the returns that industry leaders have managed to deliver. Industry leaders rather lag the league table.
As seen above, superior size does not guarantee superior performance. Many mid caps, even after the recent correction, have significantly outperformed. Needless to mention, there are varied reasons/explanations for the outperformance / underperformance displayed by the stocks. I’m also cognizant of arguments of increased risks that one assumes buying into mid caps etc. I’m neither defending nor contesting them. I am merely citing an observation.
Now that i have compiled some data, though limited in nature, that corroborates my view, i shall share it with Sean. Hopefully, it should deliver my message:
Serious money can be made in stocks, small and/or big, as long as the selection process and discipline are not compromised with. Size does not necessarily guarantee outperformance.
P.S.: (a) The data compiled in this post are from 3rd party sites like moneycontrol.com and moneyworks4me.com. There possibly could be some factual errors, not large enough to alter the findings though. (b) None of these imply any buy/sell recommendations. These are merely observations (c) The data is not exhaustive in nature. Some sectors have been considered for the study and even within those sectors, not all stocks are factored. (d) photo courtesy: drewrinvarick
Happy to hear your views.