For Indian investors, small is beautiful. The BSE Small Cap index has delivered 118 per cent return since last September, even as its large-cap counterpart, the Sensex, panted way behind, with a 59 per cent return. That is not all. Investors in stocks such as Symphony, Greenply and Ashoka Buildcon have seen their holdings appreciate manifold since the beginning of 2014.
But does that mean you should rush to buy these stocks? No. Investing in Indian small-cap stocks is a high-risk game. While you have a small probability of making mind-boggling returns, the chances of making losses are much higher. Lack of sufficient information, poor corporate governance and very thin liquidity are some reasons why these are best avoided.
But if you are one of those who revel in adrenaline-pumping activities such as bungee jumping, you might want to put some of your money into these stocks; just for thrills.
We considered the returns of 1,648 stocks whose market capitalisation was less than ₹200 crore on April 1, 2004. A chunk of these stocks — or 44 per cent of the universe — recorded a price increase between 1 and 10 times. About 17 per cent gained between 10 and 100 times. The proportion of stocks gaining more than 100 times was miniscule at 1.4 per cent. This creamy layer includes stocks such as Symphony (1,680 times returns), TTK Prestige (231 times) and Cera Sanitaryware (180 times).
In comparison, 63 per cent of the large-cap universe chalked up gains between 1 and 10 times in the past decade. There were 93 stocks with market cap greater than ₹2,000 crore towards the beginning of 2004. This is comparable to the mid-range of the small-cap stock performance. But when it comes to stratospheric returns, only 12 per cent of the large-cap stocks could multiply their prices more than 10 times. Again, while the largest gainers among the small-cap lot notched up gains between 100 and 2,000 times, the best performer among the larger stocks was Kotak Mahindra Bank, which gained 28 times in the last 10 years.
So, what is the risk involved? Around 22 per cent of the smaller stocks witnessed price erosion in the past decade. That is, one in every five stocks was a lemon. Large-cap stocks emerged a clear winner, with just 8 per cent of the stocks seeing price erosion.
Higher volatility in smaller stocks You can go for small-cap stocks but be prepared for greater volatility. The bull and bear markets in small-cap stocks in India have coincided with similar phases in the broader market. If we consider the movement of the BSE Small-cap Index and the Sensex since 2003, the rallies and declines in both the indices have begun and ended at the same time. But there is great variance in the magnitude of the rise and fall.
The small-cap index has recorded much sharper rallies and higher declines. For instance, between April and December 2003, the small-cap index rallied 172 per cent while the Sensex gained 97 per cent. In the 2008 crash, the Sensex lost 56 per cent while the BSE Small-cap Index lost 77 per cent. In general, the declines and rallies in the small-cap index are twice the moves in the Sensex.
Smaller stocks, due to tiny or small equity base and (often) low public-holding, tend to be more illiquid than their larger counterparts. This makes impact cost much higher. Their low liquidity causes exaggerated moves with just a small order. Absence of large institutional investors makes it easy for operators to put in circular trades to take the stock price higher.
How to pick a multi-bagger? A look down the list of small-cap stocks that have been super gainers in the past decades throws up a lot of well-known names interspersed with stocks that you should not touch even with a barge pole.
If we consider only those stocks with sound underlying fundamentals, these are the themes that have delivered strong returns between 2004 and now.
Investors appear to have bet on companies that possess brands that consumers swear by. Symphony, the largest producer of water coolers in the country, is one such company that heads the list of multi-baggers. Its market cap grew from ₹4 crore to ₹6,800 crore in 10 years, a gain of over 1,680 times.
Zydus Wellness, the maker of the Everyuth skincare range, TTK Prestige, La Opala RG and Cera Sanitaryware are others that have delivered good returns driven by their strong brands.
The consumption theme has also ruled over the past decade. With increasing rural and urban income, consumers in India have been on a rampage in the past decade.
Small-ticket consumer durable makers such as Butterfly Gandhimathi Appliances, TTK Prestige and Hawkins Cookers feature within the top 15 market price gainers. Other durable makers such as Havells India, Bajaj Electricals and IFB have also delivered multi-fold returns in this period.
The past decade also witnessed a boom in real estate.
Many real estate companies witnessed significant expansion in their market capitalisation. These include Anant Raj, Ashiana Housing and Poddar Developers. Industries, and so companies, allied to the real estate sector, such as Greenply, Cera Sanitaryware and Somany Ceramics have indirectly benefited from this boom and were hence marked up.
Pitfalls to avoid At a superficial level, there appears to be a lot of fun and frolic in the small-cap space. But that is not so.
Here are a few pointers that can guide you if you are determined to buy smaller stocks
Check for the level of disclosure that the company makes. Companies that are written about frequently in the media and with approachable management could be less risky. Companies that do not have a website are a clear no.
You have to be really careful about the corporate governance of smaller companies. Run a search of the intended stock, look at SEBI’s website to find out if the company was ever hauled up for any irregularities.
When in doubt, follow the smart money. If institutional investors have invested in a company, it ought to be relatively safe. It is best to delve a little deeper and look at which funds are holding the stock. Stocks that are owned by domestic mutual funds ought to be preferred over those owned by foreign funds.
Finally, check the liquidity in the stock you intend to buy. For, you need to find buyers on the day you decide to exit your holding.
Small-cap bets Against this background, there are few small (and safe) stocks that are interesting. But given the scramble after small-caps over the past year, the prices of these stocks have been pushed really high, making valuations very steep. It is suggested that you keep them on your radar to buy at an apt juncture.
The real estate story is likely to play out a little longer, given the continuing demand from the residential sector. Ashiana Housing, which focuses on tier-2/3 cities and homes for senior citizens, operates in one of the more promising niches in this sector. Earnings grew 40 per cent in the September quarter while constructed area recorded 40 per cent growth. Low leverage makes this company superior to its peers in the sector.
Greenply Industries is yet another play on the expected growth in residential and commercial real estate. It has about one-third share in the organised market for plywood, a large presence in the fast-growing laminates and medium density fibre segment. The company has grown about 24 per cent in the last five years. Its plans to move into value-added products stand it in good stead.
It is hard to separate Indians from their gold. PC Jeweller is a small-cap stock that can make the most of this trend. The company is on an aggressive store expansion drive. With falling gold prices and a relatively stable rupee, demand is expected to be strong. The expected import curbs can affect the short-term performance of the company. Stock price declines due to short-term concerns should be viewed as buying opportunities.
Improving infrastructure is the top priority of the Government and one stock that can gain from this drive is Ashoka Buildcon. This company is less leveraged than its peers with debt equity of 2.5 times. Toll revenues from a strong portfolio of completed road projects will support revenue growth. Annualised growth in toll collection has been an impressive 48 per cent over the last three years.
Eros International, a film production and distribution company, offers good return potential in the years to come. The company makes movies across budget sizes and is able to reduce business risk by monetising the cable and satellite rights for such films.
The growing trend of working mothers and nuclear families is in favour of Treehouse Education and Accessories, a company that operates pre-schools. With pre-school penetration of less than 1.1 per cent in India compared with almost 100 per cent in some developed countries, the company is likely to clock good growth. Strong revenue and earnings growth, hefty margins and low leverage are other positives.
Demand for lead from automobile companies and the back-up power industry makes Gravita (India) another interesting small-cap bet. It has been recording steady revenue and profit growth over the last four years. Almost half its products are exported. Expected capacity expansion and increased demand with the revival in automobile sales will help the company in the years ahead.
Read also: >A closer look at the small ’uns