Good time to invest in small, midcaps? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Good time to invest in small, midcaps? 

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In this issue:
» Chinese regulator aims at deterring banks from high risk assets
» Foreign investors taking a wait and watch approach
» Internet - the preferred advertising platform
» India requires more energy
» and more....

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00:00  Chart of the day
Midcap and smallcap stocks have taken a severe beating of late. While the BSE Mid Cap Index has fallen by 14% in the year till date, the BSE Small Cap Index is down by 21% during the same period. As reported by leading business dailies in the recent past, the reasons for such declines are various. These include general aversion from high risk companies, banks offloading pledged shares, decline in earnings, amongst others. There was also news of the Securities and Exchange Board of India (SEBI) looking to crack down broker-promoter collusions which added to the pessimism. In any case, with the sharp decline, it is a matter of time before investors start relooking at opportunities in the mid and smallcap spaces.

However, a cursory glance at the valuations of midcap and small cap stocks would make them expensive at the current juncture. In fact, they seem to have been so for a while now. We say this because the P/E ratios of these indices have been higher than that of their larger peer, the BSE-Sensex .

As you can see from the chart below, while the gap in valuations has reduced substantially - midcaps have become cheaper by 20% YTD, while smallcaps have become cheaper by 15% YTD - in recent times, the two indices representing the small companies are still trading higher in terms of valuations.

Data Source: ACE Equity

But at the same time, there has been a huge erosion in earning per share (on a trailing twelve month basis) which makes the scenario all the more confusing for investors as to whether it is a good time to invest in smallcaps or midcaps.

One could play it safe by investing and focusing on larger companies. But the returns from the same would not be very lucrative. That is due to the stable earnings growth from Indian blue chips. For that extra boost to a portfolio, we believe a certain amount of exposure to mid and smallcaps would be good. But it may be noted that this would be subjective to one's risk profile. At the end of the day, midcaps and smallcaps are high growth but high risk companies. Due to the same, too much exposure to such stocks is not ideally desired as well.

We have created an asset allocation guide to guide investors towards the same. This is an effort to highlight the various factors influencing asset allocation in equities and also guide investors towards how to allocate equity investments so as to achieve optimum returns from them.

Do you it is a good time to invest in smallcaps and midcaps? Please share your comments or post them on our Facebook page / Google+ page

If India has to take its growth to the next level, foreign investments will play an important role. So what is the stance being taken by these investors currently? Most of them are waiting for general elections before they decide the next step. The past one year has seen the Indian government being criticized for its failure to undertake serious reforms. This put a question over the amount of foreign direct investment (FDI) that would come into the country. Wanting to break this status, the FM announced a slew of reforms since then. But it will be a while before these begin to take shape. The silver lining in the cloud is that foreign investors have not lost interest in the country and do intend to invest. But because of so much political uncertainty, they are looking for the right time to invest in the Indian economy.

Time and again the risks surrounding the Chinese banking system have been highlighted. But now there is a new type of risk that has come under the scanner. The risk is in the form of something called wealth management products. The Chinese banks have been offering these products as a high yield alternative to traditional bank deposits. The latter offer very low interest rates as the same are decided by the government. The wealth management products invest money in anything starting from government securities to loans to developers to gold. The amount is at times invested in loans which may otherwise be rejected by the banks owing to their high risk profile. This poses a major risk to the entire financial system. For in the event of a default, these products would end up losing their value. This in turn would hurt the depositors to whom these products are being sold to. Given that the four biggest banks of the country have an exposure of over US$ 467 bn to such products, it is necessary to regulate these. As a result, China's banking regulator has come up with a set of regulations that demand banks to give full disclosure of such products. The regulator hopes the full disclosure would deter banks from investing in the high risk assets. The point is that more complicated the product is, the more the chances of things going wrong. Traditional equities, bonds and deposits are always better investment options. But in the greed of earning higher returns, investors get lured into the complicated products. And unfortunately they don't wake up to the perils of these products till they burn their fingers.

The internet has radically changed the world of advertising. Traditionally, TV commercials, print advertising and billboards have been the most important media of advertising. But these traditional forms have started losing their effectiveness. The trend is now shifting towards internet advertising.

An article in Business Line presents some interesting figures. The total global spending on advertising stood at about US$ 497.3 bn in 2012. This was 3.3% higher than previous year. However, internet emerged as the fastest growing sector. It now accounts for about 18% of the total global spending. The Asia-Pacific region (excluding Japan) led the pack with a growth of 7.9%. It is said that the expansion of the social media and online video advertising are major drivers for the growth in internet ad spends.

Rs 1,920 crores. This is the amount of money that we've sent out more than bring in during the December 2012 quarter on a per day basis. In other words, we have shipped out close to Rs 2,000 crore extra per day during the quarter to pay for various goods and services. And as simple logic would suggest, when we spend more than we bring in, we either have to raise debt or sell our assets. This is exactly what our current account deficit problem is all about. As highlighted earlier, the deficit went up to a whopping US$ 32 bn during the December quarter. This is a historic high of 6.7% when measured on a percentage of GDP basis.

The deficit no doubt has some cyclical excess to it and hence, would come down in the coming months. But it will still be a deficit nevertheless and thus would continue exerting pressure on our currency. Not to mention our continued reliance on capital inflows to fund the same. There are of course experts who argue that a small current account deficit is perfectly normal for an emerging economy like India. But why have even that as per us. Why can't we make our exports so competitive that we have both a trade surplus as well as higher capital inflows? Growing its GDP while still having a current account deficit is certainly not our idea of quality growth.

After gold, it is oil that weighs heavy on India's current account deficit. After all, the country imports around 80% of its oil requirements. Even then, India's oil minister has set an ambitious target of energy self-sufficiency by 2030. Considering that the government expects India's oil demand to grow by 40% over the next decade, the target for energy self sufficiency looks steep. To put things in perspective, the domestic oil output would have to multiply just to be on an equal footing with imports. In fact the domestic output will have to more than triple just to meet current requirements. For the US, the energy self-sufficiency target may look more feasible considering the shale gas reserves. But for India such resources are yet nowhere in sight. However, steps have been taken in recent times. The quest to boost domestic oil and gas production has led the government to cut through some red tape. Also some energy pricing reforms have finally come through. We can only hope that the measures bring in critical energy resources and allow India to move in the direction of self sufficiency.

The global stock markets witnessed a mixed performance over the week. The major European stocks ended in the negative. This was on account of a selloff in banks as the leader of Italy's Democratic Party ruled out the possibility of a consensus on a broad coalition government. However, the US stock market ended in the green (up 0.5%) on the back of a strong economic data and relief after banks in Cyprus reopened following a two-week closure.

Barring China (down 3.9%), the major Asian stock markets witnessed gains over the week as they reflected the good news out of the US. Indian stock markets ended the week in the green, up by 0.5%. This was largely due to heavy buying in ICICI Bank, Infosys, Larsen & Toubro, ITC and Oil & Natural Gas Corporation shares, amid settlement of monthly derivative contracts.

Data Source: Yahoo Finance, Kitco

04:56  Weekend investing mantra
"Stick with businesses whose profit picture for decades to come seems reasonably predictable." - Warren Buffett

  • Warren Buffet - The Value Investor
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    1 Responses to "Good time to invest in small, midcaps?"


    Mar 30, 2013

    Though it appears to be a right time to invest in small & midcaps, due to the volatile political situation in India, there is a good possibility of Sensex going down further in the near future and Small & mid cap stocks will also be equally affected. As per your chart a P/E ratio of 11 for Small Cap & about 16 for Mid cap gives a strong support.

    Investing at this level of P/Es will give a good opportunity for better returns. My preference will be to wait & watch till such time.

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