Decoded: Why m-cap is vital for companies and investors alike

While m-cap is a good measure of a company’s reliability as an investment, a careful read of balance-sheets and sectoral trends is just as important

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Last week, seven of India’s top 10 most-valued companies added Rs.1.15 lakh-crore in market capitalisation, with RIL leading the pack.

Last week, seven of India’s top 10 most-valued companies added Rs.1.15 lakh-crore in market capitalisation. Reliance Industries Ltd (RIL) led the pack, adding ₹60,668.5 crore to take its valuation to ₹13,88,718.4 crore, according to a PTI report.

This is in line with the trend of the stock market performing well amid an appreciable fall in COVID cases in several parts of the country. Last week, the BSE Sensex jumped increase 677.17 points, or 1.31%. Along with RIL, corporate behemoths such as HDFC Bank, Hindustan Unilever, HDFC, State Bank of India, Bajaj Finance and Kotak Mahindra Bank added to their market girth with a significant rise in their m-caps.

Which raises the question — how important is the m-cap, be it to the company itself or to an investor in it?

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What is m-cap?

Investopedia defines m-cap as the “market value of a company’s equity”. You can arrive at the m-cap of a publicly listed company by multiplying its shares outstanding by its price per share. Based on m-cap, listed entities are categorised as large-cap, mid-cap and small-cap companies. For the benefit of investors, brokerages and mutual fund houses, the Securities and Exchange Board of India (SEBI) has created specific brackets for the three categories of m-caps.

Also read: Explained: The what, when and why of Paytm’s $3-billion IPO

Large-cap stocks are the top 100 stocks by market cap in India. Examples include RIL, State Bank of India and Infosys. Mid-cap stocks are those that are ranked 101-250 by m-cap, such as Metropolis Healthcare, Castrol India and LIC Housing Finance. Small-caps refers to all the listed entities that are ranked below 250. Among examples are DB Corp, KNR Constructions, and Hathway Cable. These are often new companies, and may also include special purpose vehicles (SPVs) of larger companies registered for specific projects.

Does m-cap indicate a company’s health?

The m-cap is a broad indication of how well-established and stable a company is. For instance, large-cap firms are typically sectoral leaders with substantial revenues, and have been recording healthy balance-sheets for several years now.

By the same logic, small-caps are often younger firms with a smaller presence in their respective sectors. What they lack in reliability and revenue-making history, they may make up for with nimbleness and the ability for quick growth. Mid-caps fall between large- and small-caps in terms of riskiness as well as capacity for quick growth.

While these are broad lines to define a company, it must be remembered that its m-cap is a function of its stock price, which ultimately is based on how healthy investors perceive it to be. And investors decided whether to buy or sell a stock based solely on the data provided to them.

The Yes Bank example

For instance, the Yes Bank share was trading at around ₹390 in August 2018 and about ₹265 in April 2019. This was because the investors perceived it as a good performer even when the rot was already happening. The company had a pile-up of non-performing assets (NPAs), there were scams around its loan processes and there were boardroom issues, too.

None of this was reflected in its m-cap. It was only when news of the scams broke out that its m-cap crashed. Today, its share price is less than ₹14.

Similarly, in companies such as Jet Airways and Satyam Computer, the m-cap reflected the companies’ health when they were doing well, but failed to spot the rot in their balance-sheets or operations. It was only when regulatory bodies or auditors dug out the problems that the markets reacted and brought down the m-cap.

What happens when m-cap falls?

When the m-cap falls, as it did for Yes Bank and Jet Airways, among others, it affects the companies to a significant extent. For one thing, it impacts their credit-worthiness — lenders are usually wary of granting loans when there is a substantial decline in the m-cap.

There is also a loss of credibility among raw material providers, dealers, joint venture partners and the consuming public when the m-cap falls. This can dent the business in a big way, though the share price by itself is not represented in the balance-sheet.

Several companies include employee stock ownership plans (ESOPs) in their pay packages. So, a fall in share price means the stocks vested with employees lose some value, which can demoralise the staff. Similarly, top management and company directors are also given shares in the company, and a fall in share price may lead to the loss of key talent.

Options for investors

When the m-cap of a company declines, the investors witness an erosion of their investment in that company. They are left with two options at this point. They can either cut their (potential) future losses and sell their shares immediately, or hold on to them in the hope that the problem the company is facing is temporary and the share price will bounce back in time.

For investors with good risk appetites, a fall in m-cap may indicate a good time to buy more shares in that company. They can accumulate the shares at a relatively lower price and reap rich dividends if the company regains its former good health. But that is a big ‘if’ and requires careful consideration.

A serious investor in equities, however, will devote only some of his/her focus to m-cap as a parameter to gauge the health of a company. Looking at the individual company’s balance-sheet, growth plans, market practices and sectoral trends — or entrusting an expert with the process —would be a more sound investment policy.

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