Small Cap Stock Performance
Out of total 777 small-cap stocks, almost 66 % stocks have delivered positive returns over a one year period. At least 8.62 per cent of the 777 stocks, i.e 67 companies have more than doubled in over one year.
More than 16 per cent of the small-cap stocks, i.e 125 companies have delivered returns between 50 to 100 per cent over the last one year. Almost 134 companies or more than 17 per cent of the small-cap companies generated returns between 25 per cent and 50 per cent in the period under consideration.
Small-cap stocks continue to outperform the major benchmark indices. How long do you think this outperformance will continue?
Historically, in the various time periods leading up to market peaks – 3, 6 and 12 months – the small-cap stocks have most of the time outperformed the large cap peers and under-performances have been marginal. During periods where small-caps have outperformed their larger counterparts (represented by a wide margin), the decline thereafter has been just as sharp.
With the outperformance occurring this time around as well, that too at a quick pace, it would be prudent to book some profits. Having said that, one key factor that is different this time around is the overall improvement in the balance sheets of the small-cap companies, which has led to a broad-based re-rating within stocks that form part of the index that represents small-caps. This is one factor that makes a historical comparison not so easy, and thus, taking a stock-specific call is the way to go about things.
What are the common misconceptions surrounding small-caps?
Investors often confuse ‘cheap’ with the absolute price of a stock. For example: a company, whose stock trades at ₹5 would often be considered as a more attractive investment than one whose stock is trading at ₹1,000. One cannot be any more wrong. Let’s assume two companies have the same annual profit figure of ₹1 billion. One company has 1 million of shares outstanding, while the other has 1 billion shares outstanding. The EPS thus is INR 1,000 in case of the former and INR 1 for the latter. If we assign both the companies the same earnings multiple (assuming all other things being equal) of 14x, then their shares would trade at INR 14,000 and INR 14 respectively. One may be easily fooled into thinking that a stock trading at ₹14 can rise to ₹18 much easily than an investment of INR 14,000 rising to INR 18,000.
Prominent examples of how large value stocks have outperformed include MRF and Eicher Motors. Investors should instead gauge attractiveness in the form of the various valuation methods – with the key ones being, dividend yield, price-to-equity ratio, free cash yield, among others.
Another common misconception is that small cap stocks are more risky because of their size and sharp movement in stock prices. A company earning very strong and stable ROCES and margins with good operating cash flows and steady growth, but having a market cap of INR 300 cr could be a much more attractive investment (i.e. when invested at a fair price) as compared to a largesized behemoth with not so great fundamentals (having cyclical business and commodity-product business traits) trading at similar valuations. Also, price volatility in stocks can in fact be used to one’s advantage, rather than being considered as a risk.
At this moment, would you prefer investing in small-caps instead of mid-cap and large-cap stocks?
For an individual to have a healthy investment track record, it is equally important to cap the decline as it is important to get upside calls right. Given the run up in stocks, valuations have become a bit stretched when gauged from a broad perspective. To justify the same, the earnings performance will have to match up.
At the end of the day, valuations are determined by factors such as the quality of earnings, the predictability of those earnings and the staying power of companies. Instead of classifying stocks as mid, small or large cap in nature, one would do better to look at the qualitative factors like financial ratios, balance sheet strength, stance in industry, the changing industry dynamics, competitive pressures, amongst others. An investment in a company with good economics and growth prospects is bound to fare well over the long run, even if not purchased at the cheapest of valuations.
❝Taking a stock-specific call is the way to go❞ Nitasha Shankar Sr. Vice President and Head of Research YES Securities (I) Ltd.
❝Creating value for all stakeholders is the fulcrum of our business❞ N Srinivasan Executive Vice Chairman & Managing Director Cholamandalam Finance Initially, we were concentrated in South and our operations were limited to few products and geographies. Dependence on banks for funding and limited access to capital market was also a hurdle.
How has been your journey from being a relative small player in equipment finance player in 1978 to a large diversified financial service provider currently?
It has been an amazing journey so far and we have been able to touch so many people’s life. In our journey covering four decades, we have grown our clientele to over eight lakhs. The growth of Chola can be attributed to our ground level understanding of the customer’s profile and their credit needs, which helped us to innovate and customize products to suit their needs. With better product lines, lower cost, wider and effective reach, strong risk management capabilities to check and control bad debts and better understanding of our customer segments helped us not only achieve success in vehicle finance business, but we have also managed to build substantial assets under management (AUM) in the housing finance sector. At Chola, integrity, passion, quality, respect and responsibility are our five lights and all our actions are governed by these guiding principles. All the above have enabled us to grow from an equipment financing company to a comprehensive and full-fledged financial services provider.
In your opinion, which factors were the absolute drivers of growth for the company?
Strong pan-india presence, key focus on rural and semi-urban sectors, well-diversified portfolio of asset financing products, experienced management team with unrivalled industry experience, strong backing and exceptional lineage from the Murugappa Group.
What were the key growth challenges faced by your company at the initial stages?
Initially, we were concentrated in South and our operations were limited to few products and geographies. Dependence on banks for funding and limited access to capital market was also a hurdle. The financial sector reforms in the early 90s, liberalisation of regulatory control over markets, institutions and instruments, along with rationalised regulatory framework in 2000s enabled NBFCS to function as a catalyst to economic development of the country.
What are the major strategies of the company that have helped it grow over the years?
Positioning Chola as a strong asset financing company, creating business value through technology innovation, strong dealer and manufacturer relationship, highly experienced and stable team and customized product offerings for our target customers.
How do you compare the business environment today to the environment in 1980s when it was early days for your company?
The business environment in the 1980s was very restrictive for NBFCS because of the non-availability of instant credit and regulatory restrictions, while the current business environment and the Industry outlook is very encouraging. NBFCS play an important role in nation-building and financial inclusion by complementing the banking sector and reaching out credit to unbanked segments of the society. Going forward, the latent credit demand of an emerging India will allow NBFCS to fill the gap, especially where traditional banks have been wary to serve.
Additionally, improving macroeconomic conditions, higher credit penetration, increased consumption and disruptive digital trends will allow NBFCS' credit to grow at a healthy rate. The RBI is constantly striving to bring necessary changes in the NBFC regulatory space to proactively provide regulatory support to the segment and also to ensure financial stability in the long run.
In the current environment, alternative credit scoring methods are used on multiple data sources, which enables informed underwriting, thereby reducing default rate and providing instant decision-making. This improved underwriting practice enables in financial inclusion and has the ability to reach a diverse and widespread audience. This was not the scenario in the 1980s as the credit manager had limited data for evaluating the credit worthiness of the customer.
In the journey so far, has there been any shift in vision and mission of the company?
There has never been any shift in vision and mission of the company. The vision of Chola is to enable customers enter a better life. Ever since its inception and all through its growth, the company has kept a clear sight of its values. The basic tenet of these values is a strict adherence to ethics and a responsibility to all those who come within its corporate ambit - customers, shareholders, employees and society.
A good stock is a good stock to buy, notwithstanding its market capitalisation. Investors should not get carried away by the recent run in small-cap stocks. Small-cap stocks seem to be extremely popular with the investing community lately due to their recent performance. Also, due to tapering of growth in large-caps, investors find relative higher growth in small-caps attractive. It is widely perceived that small-cap investing is risky. The fear of small-caps being extremely volatile may be overblown, as our research suggests that small-caps in the long run are not as volatile as they are perceived to be. With the global fund managers looking positively at emerging market small-cap stocks as an asset class within equity, chances are that there will be no dearth of liquidity in small-cap stocks.
With lot of investors' attention, both retail and institutional, on small-cap stocks, one needs to only avoid highly leveraged stocks with poor earnings outlook. In the current market scenario, with slowdown in GDP and expensive valuations, the expectation on small-cap stock returns need to be realistic. We believe that small-cap stocks as a category may still outperform their peers in large-cap space. However, the returns in the coming years may not be as high as we have seen in the previous three to five years.