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How to pick midcap stocks that may become mega caps? Raamdeo Agrawal shares formula to earn handsome returns

midcap, smallcap, Raamdeo Agrawal, Motilal oswalThe top 100 stocks are the bedrock of India’s capital market, and it’s difficult to dislodge these mega companies from their position, said Raamdeo Agrawal. Image: Reuters

Motilal Oswal group Chairman Raamdeo Agrawal has shared insights for investors to identify mid cap shares that can turn into mega cap stocks in just five years, generating as high as 40% annual returns. Mid cap shares that climb up the mega cap ladder generate more handsome risk-adjusted returns than those that crossover mini-to-mid, mini-to-mega, or mega that remain mega. The top 100 stocks by market capitalization are classified as mega or large caps; the next 200 stocks are mid caps; and all other remaining stocks are mini or small caps.

Mini cap, Mid cap, Mega cap stocks returns comparison

The top 100 stocks are the bedrock of India’s capital market, and it’s difficult to dislodge these mega companies from their position, said Raamdeo Agrawal. Investors earn indexed returns on investing in mega companies, growing wealth at 15-17 per cent per year. On the other hand, the companies that transition from mini caps to mega caps have shown to return as much as 45% annualised gains, but there’s a very low probability of correctly identifying such stocks.

Mid-to-Mega a sweet spot to identify handsome returns

Mid cap-to-mega cap, i.e. stocks transitioning from the top 300 to the top 100, is a sweet spot to look for potentially high return generating opportunities. In every 5-year period, 13-15 companies turn mid-to-mega, Raamdeo Agrawal said. A midcap company, even to just maintain its ranking, must grow by 15% per year, which is a difficult feat. A midcap company climbing up into the mega cap category has to create wealth at a significantly higher rate of 25-40%.

A midcap company, even to just maintain its ranking, must grow by 15% per year, which is a difficult feat

Raamdeo Agrawal shared a Motilal Oswal study of 2,930 companies during March 2016-March 2021, comprising 100 mega stocks, 200 mid caps, and 2,630 mini shares. Out of 2,630 mini companies, 32 companies crossed to mega, giving a return of 45 per cent. But the strike rate was low at just 2 per cent, translating into high downside risk. During the same period, 13 of the 200 mid cap companies crossed to mega, giving 38 per cent return at a strike rate of 6.5 per cent, implying a low downside risk. Raamdeo Agrawal advised investors to focus on mid-sized companies, instead of very small companies, as it could provide a strike rate of 6-7 per cent with higher probability of success.

What does it take to achieve the Mid-to-Mega transition?

A lollapalooza of MQGLP with industry leadership helps to achieve Mid-to-Mega. MQGLP stands for Mid-size (of company ie market cap rank 101-300), Quality (of business and management), Growth (in earnings), Longevity (of both quality and growth) and Price (favorable valuation). Investors must find mid-sized companies with good quality of business and management, and potential earnings growth, with longevity. Then they must see longevity and availability at a reasonable price, and then see if the company has the industry leadership. The company might look very simple, but the moment it has industry leadership, and also QGLP, it increases the probability of higher returns.

Every 5-year window offered Mid-to-Mega opportunities across sectors

Raamdeo Agrawal found Mid-to-Mega to be time and sector agnostic. Thus, every 5-year window offered Mid-to-Mega opportunities across sectors. Based on the case studies, all companies that crossed over from Mid-to-Mega have handsomely outperformed the benchmark.

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