Investing in small-cap stocks is in vogue globally as small-cap stocks are considered long-term investors' best friends. Yogesh Supekar and Tanay Loya hunt for the best small-cap stocks available for investment at the current juncture and recommend stayin
Sensex is up by nearly 14 per cent over the past one year and is trading at 18.6 times its projected earnings. Nifty has moved from 20.95 P/E multiple to 25.89 over the past three years. With corporate earnings yet to see signs of revival, majority of analysts believe valuations are on the higher side. While valuation concerns and global geopolitical tensions are affecting the market moods, small-cap stocks continue to impress investors with their performance.
Small-cap investing is again the talk of the town as the category continues to outperform its peers on the Indian bourses. Well, we observe that the trend is global and not restricted to India. The small-cap equity as an asset class has outshined all the other asset classes on multiple year basis.
Popularity of mutual fund investing has a lot to do with the liquidity in the markets today. Lack of investment choices are driving many investors towards mutual funds in India. Balanced funds, small-cap funds and mid-cap funds are amongst the most popular categories of mutual funds with investors in recent times.
The rebalancing of asset allocation of Indian investors is in progress and mutual funds are its biggest beneficiaries. With mutual funds being one of the biggest beneficiaries, small-cap stocks become a natural beneficiary indirectly as the fund managers deploy the new funds in high growth small-cap and mid-cap stocks. We can say that retail
investors' continuous buying of equity via mutual funds has pushed the equity valuations higher.
The million dollar question is: Will the small-cap outperformance continue in the coming years and whether investors should allocate more of their funds to the category. The answer definitely is not as easy at it may seem, because historically, we have seen that when markets are in consolidation phase, the small-caps have a tendency to crack more than their large-cap peers. Having said that, any correction due to the global geopolitical factors or high valuations should present investors an opportunity to enter the markets.
Owing to some extraordinary performance by the small-cap category over the last 5 years, retail investors are increasingly showing interest in parking their funds in the small-cap stocks.
While there may be little doubt that small-caps can be more volatile than their large-cap peers, retail investors have a preference for the category looking at the return potential. Says Suraj Agarwal, who is an HNI and has been investing in stock market for more than 16 years now, “Small-caps, if chosen carefully, give excellent returns across all market conditions.”
WHY SMALL-CAP STOCKS CAN BEAT LARGE-CAP STOCKS
Even as the future of a small company may seem unpredictable, they are quick to rebound faster in the developing economies as compared to the larger companies. The growth momentum of these companies do not directly rely upon the macro factors of the economy such as interest rates, unlike larger companies.
The small companies typically rely on investors rather than borrowing funds to raise capital, unlike large companies whose vast needs of funds are mostly met with high amount of borrowing. This makes the small-cap companies immune to any changes in interest rates, besides keeping the likely burden of surmounting interest cost at bay.
Small-cap companies (and most growth-oriented stocks across all market caps) typically raise most of their capital from investors (by selling shares of stock), as opposed to borrowing money (by issuing bonds) like larger companies. Therefore, higher interest rates have less negative impact on the ability of small companies to grow, because they do not rely heavily on loans (bonds) to expand operations and fund projects.
Small companies are able to take more rapid decisions about products, services and operations with lower instances of red-tapism and bureaucratic impediments, unlike large enterprises.
Thus, small-cap stocks make for an investment haven, especially at a time when the economy is recovering from a slump or a recession. In an environment conducive to growth, the small-cap stocks respond more quickly and potentially grow at a faster pace as compared to the large-cap stocks who have much higher stakes.
ECONOMY OUTLOOK :-
Stock market fortunes are linearly related
to the economic growth of the country in the long run. Recent economic data suggest there is a visible slowdown in the Indian GDP growth. On the negative side, the GDP growth has slowed down and the Index of Industrial Production (IIP) contracted 0.1 per cent YOY in June 2017, as against 8 per cent growth in June 2016. India's gross domestic product rose 5.7 per cent in April-june from a year
earlier, missing the economists' estimates. The gap between the index P/E multiple growth and GDP growth is also at multiple-year highs.
On the positive side, direct tax collections jumped 19 per cent in the four months of the current fiscal, as demonetisation of higher denomination currency bought in more number of individuals into the tax net.
Says Sanjeev Prasad, Co – Head and Managing Director, Kotak Institutional Equities , “We believe market participants may be ignoring the structural challenges to India’s GDP growth by overly focusing on the cyclical factors of demonetisation and GST. In our view, weak investment demand (30% of GDP) is a far bigger ‘structural’ challenge for the economy. We are not sure how this will change in the short term. We note that continued weak investment will affect consumption eventually, high government expenditure notwithstanding.”