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Is it the time to ignore smallcaps?

Jan 9, 2015

In this issue:
» Are NPA infested banks going to have respite soon?
» Does OPEC want oil prices to fall?
» Is China staring at deflation?
» ...and more!

  Chart of the day
First things first. Investing in small cap stocks in not for everyone. Not for those without the appetite to invest in relatively higher risk companies. And certainly not for those who wish to become rich overnight. As our experience since 2008 tells us, the best way to make money in small caps is to invest with a reasonably long time frame in mind. This helps take advantage of the growth as well as improvement in valuations.

But the performance of small cap stocks in India over the past six months, has turned the logic of long term investing on its head. Stocks in the small cap index have multiplied several times within six months flat. And as a result, even investors who stayed away from stocks prior to 2014 have got hooked to small caps. These stocks have become the surest recipe to quick riches!

So on hand you have brokers trying to endorse the overnight money making opportunities in small caps. On the other you have business papers pointing out that small caps in India are amongst the most expensive in the world. The average price to book value multiple of Indian small caps is almost that of small caps in the rest of Asia. A look at companies in the index with profitable consolidated bottomline for FY14, will show you ones with PE multiple of upto 300x!

Are Indian smallcaps the most expensive in Asia?

So should you be buying small caps at the moment or dumping them? Richa, who is the editor of Hidden Treasure, has been deftly replying to scores of such queries that have been coming in from investors. And the crux of her reply is that there is no single formula for investing in small cap stocks. The variety of businesses in the space, their scope of growth and their management quality need to be very carefully evaluated to judge the upside in valuations. Plus it is very important to have a first-hand interaction with the management, which is what Richa and her team do before recommending any stock. This laborious exercise of rummaging through scores of small cap companies to find solid yet undervalued ones have yielded very fruitful results. And according to her, even while the small cap index may scare away investors with overtly expensive valuations, it is not the time to ignore small caps. All you have to make sure is that you invest only in the right stocks with sufficient margin of safety in valuations. Having done that all you need is the patience to stay invested.

Have you stopped investing in small caps because of the seemingly expensive valuations? Let us know your comments or share your views in the Equitymaster Club.

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Now it is not just the smallcap stocks that are having a problem. Some big and heavyweight companies in the banking sector are also seeing investors take a flight to safety! The size and quality of restructured assets in their books is the key concern. As the economy recovers, banks hope that the underlying businesses of stressed assets would recover. So that as and when these loans become good again, the provisions against them can be written back to boost profits. But the road ahead seems a long one. And unless economic recovery accelerates, the pace of recovery of loans will be a long drawn one. Rating agencies too are not very optimistic about the possibility of loan recoveries. A report by Fitch Ratings, quoted by Mint, estimates the slippage of restructured assets to be in the range of 25-30%. This is because their quality is inferior compared with that seen in the previous bull-run. So it is advisable for investors to be cautious about banks with NPA problem, despite their very attractive valuations.

How often do you see the producer of a product smile at a drastic fall in the price of its product? Not very, we reckon.

And that is exactly what the countries that constitute oil-cartel OPEC are doing currently. The price of crude tanked a whopping 48% over the course of last year. Even in the backdrop of such a rapid fall, OPEC was quick to announce that it will by no means be cutting its output of oil. Oil has seen a massive 34% fall since this announcement which was made towards the end of last year.

So is OPEC complaining? Quite the contrary. A Bloomberg report points out that some of its wealthiest members like Saudi Arabia, the U.A.E. and Kuwait have stressed over dozen times in the past 6 weeks that the group will not curb output to arrest these falling prices.

The way they have been doing this so overtly, it's almost as if OPEC is trying to talk down the price of oil. Like they actually want it to fall lower. Observers figure that this is a well planned strategy to destroy the US shale oil industry which has been encroaching on OPEC market share in recent years. If this is indeed the case, then it is likely that this battle is set to get even more heated. Which gives rise to the possibility that oil prices may be headed even lower in the near future. Quite an interesting possibility, considering how low they have already fallen to.

Talking about falling prices, crude is not the only thing headed lower. Measures of prices at the wholesale level in none other than China have been seeing persistent declines. China's Producer Price Index has been falling for the last 34 consecutive months. In fact, it saw its biggest annual fall in more than two years in the month of December, falling 3.3% YoY. Further fueling fears that the world's second largest economy may be staring at the very real prospect of being griped by deflation.

Not a very healthy sign for a country that has been growing its economy at such a brisk pace. And neither for the global economy, which until recently looked up to the dragon nation as the engine of global growth.

The Indian stock markets remained volatile through the day, alternatively dipping to and then recovering from the dotted line. At the time of writing, the BSE-Sensex was trading up by around 120 points. Gains were largely seen in IT and telecom stocks, with the BSE IT index trading up by over 3%.

 Today's investing mantra
"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share"- Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee and Taha Merchant.

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3 Responses to "Is it the time to ignore smallcaps?"

Jan 10, 2015

there are still many small caps attractively priced.. one such small cap is jayant agro organics Mcap: 187cr which is a consistent dividend paying company since inception (20 plus yrs of dividend payout)
7 yrs 588% increase in profits and 335% increase in sales
Consolidated Sales/NP/dividend numbers.
March 2007 Sales 462.49Cr Net Profit: 6.76Cr Div:1.25
March 2008 Sales 605.96Cr Net Profit: 9.51Cr Div:1.25
March 2009 Sales 875.86Cr Net Profit 7.49Cr Div: 1.25
March 2010 Sales 904.01Cr Net Profit: 12.47Cr Div:1.50
March 2011 Sales 1,175.26Cr Net Profit: 24.92Cr Div 1.75
March 2012 Sales 1,832.26Cr Net Profit: 31.35Cr Div: 2.00
March 2013 Sales 1,624Cr Net Profit: 36.24Cr Div: 2.25
March 2014 Sales 1,550Cr NProfit: 39.75cr Div: 3/=
so there are still many small caps which are available at attractive price/book jayant agro price/book :0.85



Jan 10, 2015

As a beginer,How can I Identify which stock is smallcaps,midcaps and bigcaps?



Jan 10, 2015

Tata motor lost its market share in PVs in India because of the interior finish of the vehicle is very poor compared to other PVs in India. Deferentially from the Jaguars and Land rover accusation has given a brand boost and there recent designs in India also shows some improvement And more over Tatas present in the other side of the world gives bit pride to we NRIs

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