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The midcap index has witnessed a sudden decline in the last one week, underperforming the benchmark indices. The Nifty Midcap index had lost around 6 percent in this period as against a 1 percent loss in the benchmark Nifty50 index.

This steep decline in the midcap stocks is a result of profit booking on the back of a massive run-up in the last 1 year. The Nifty Midcap index had outperformed benchmarks in the last one year, rising nearly 80% as against a 51% rise in Nifty50.

Further, as per analysts, the overvaluation of the midcap stocks cannot be justified by their fundamentals leading to the current correction in the midcap stocks.

The overall market sentiment is also down since FIIs turned net sellers in October further impacting the broader markets.

While analysts believe that quality midcaps will outperform large caps in the long run, these stocks are likely to remain volatile in the near term. They advise using these dips to accumulate quality midcap stocks instead of panic selling.

Since midcap stocks can be more volatile than large-cap stocks, it is very important for investors to choose the right midcap stocks to invest in at such times in order to avoid huge losses in the future.

But how does one choose the right midcap stocks to invest in? These are a few things investors must keep in mind before investing in a midcap stock.

Liquidity: A number of midcap stocks do not have adequate liquidity. This means they do not trade in huge volumes on a regular basis. If an investor buys midcap stocks with low liquidity, it may become difficult for them to get rid of in case of a crash. Hence, an investor must focus on midcap stocks where liquidity is not an issue. He/she can look at stocks that are a part of major midcap indices since these are more known among investors and actively covered by analysts.

Transparency: This is another important feature to keep in mind before investing in a midcap stock. Only midcap stocks which have regular analyst meets, conference calls, do not delay earnings reports and are covered by brokerages should be looked at. These stocks are more transparent and it will be easier to track and analyze their fundamentals. Also, more brokerages will cover these stocks, giving investors more detailed analysis and helping them make the right decision.

Herd Mentality: Never buy a midcap stock just because everyone else is buying. Many-a-times investors get influenced by tweets, WhatsApp messages where a number of people are buying a certain stock. It is important to not get swayed by the popularity of a stock and do your own research to make an informed decision.

Earnings and other research: Before investing in any stock it is important to look at their earnings of the last 5 years. While it is important that the company has posted strong earnings in the last few quarters, it is also important to check how its rise has been over the years, whether it has been consistent or not. Focus on companies that have witnessed a stable rise over the years and have been less impacted by sudden economic concerns. Not just earnings, investors must also look at stocks with strong management, smaller debt, expansion plans, etc before investing in a midcap stock.

Past performance: Investors must also look at how the stock has performed in the last few years. It is advisable to invest in stocks that have shown resilience to market fluctuations and have outperformed markets during crashes. Stocks that are less impacted by market swings and are able to hold their own during those times are considered better investments.

Holdings: Another important factor to consider is the ownership of the stock among promoters, FIIs, mutual funds, DIIs, etc. Invest in stocks where the holdings of MFs, FIIs, DIIs are consistently increasing instead of decreasing. Also, invest in stocks with a prominent promoter holding like 35-40 percent since it reflects their commitment to the firm. Hence, it is important to go through the shareholding pattern of the stock for the last few years before buying.

Future upside: Before investing in a midcap stock, investors must also contact their brokerage or research other brokerage reports to figure out the upside potential of a stock. Brokerages consider a number of factors like technical ratios, earnings, management before deciding the upside potential of a stock. So combing through a few brokerage reports as well as contacting your brokerage can help you make the right decision.

Peer comparison: Investors must also compare the fundamentals and technicals of the stock they are interested in buying against those of its peers. Instead of buying the first good stock you come across, compare the P/E ratios, RoEs, past performances, fundamentals and choose the better performer.

Midcap stocks have great growth potential and can be used as a diversification instrument for your portfolio. However, since the return potential is higher so is the risk as it can be greatly impacted by market swings. So only investors with a moderate to high-risk appetite should consider investing in these stocks.

However, if you choose to invest in midcap stocks, do keep in mind the above parameters and do thorough research to pick the right ones which fit your portfolio, financial goals and investment horizon perfectly.

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