The Small Secret to Smallcap Investing
(Oct 16, 2015)
|A A A
In this issue:
» Risk aversion vs. Loss aversion
» The economic threat from bank frauds
» Engineering exports antithesis to Megatrend?
» ....and more!
Imagine tomorrow morning you see a profit of Rs 5,000 in your portfolio.
But later you realise that you have lost your wallet carrying Rs 5,000.
What thoughts will you go to sleep with - the satisfaction of having earned 5,000 or the remorse of having lost 5,000?
I bet you will rue the lost money for days and do your best to recover that loss. The fact that, having gained 5,000, you are neither better nor worse off won't make you feel better. This is because most of us have been trained to treat gains and losses very differently.
This is why investors aren't jubilant about small profits, but a string of small losses can cause panic. If you were to ask Buffett, he would explain this as the difference between 'risk' and 'loss' aversion.
Just like insurance businesses account for possibility of small losses in return for tremendous long-term gains, investors need to recognise that small losses are part of the deal.
This is especially true in small cap investing.
Here you seek to buy small businesses, typically with few products and limited moats. The possibility of growth, though evident, is not certain. And the business' ability to overcome various challenges is untested.
Stocks like these typically slump with few quarters of unacceptable performance. Investors turn loss averse.
'It's already down 30%. What if it loses another 20%?' they fret. The fear of losing money is so strong that they can't see that the downside has diminished while the up side has gone up. Such investors are loss averse.
But smart investors would rather be risk averse than loss averse.
Of course, it is important to know if the business is fundamentally sound and backed by a capable management. Then all we must do is determine if the stock is available at a good discount to its intrinsic value. If indeed the fundamentals and valuations are solid, it is a brilliant opportunity for the risk averse investor. The margin of safety will minimise the downside risk. Whereas the upside is all profit.
When investing in small cap stocks, you have to be aware that you are courting the risk of loss. Not just loss of profits but in some cases the loss of capital as well. But the solution isn't to sell or avoid every small cap stock that is going down. Instead, if you take the pains to develop risk aversion rather than succumb to loss aversion, you won't lose sleep over small, temporary losses.
My colleague, Richa Agarwal, Managing Editor of Hidden Treasure, never fails to remind subscribers to limit their exposure to small caps. She recommends to never increase exposure to a stock beyond 3-5% of the portfolio. That is just one of her way to practise risk aversion. She also insists on great track records when considering investing in businesses facing temporary headwinds.
The next time you're hesitant about a solid small cap company, ask yourself if you are being loss averse or risk averse. Embracing risk aversion is a small but central secret to successful small cap investing.
Do you think getting risk averse instead of loss averse will improve your chances of successfully investing in smallcaps? Let us know your comments or share your views in the Equitymaster Club.
--- Advertisement ---
Why Little-Known Companies Could Make You Big Returns...
Some little-known and barely heard of companies could be the star performers in your portfolio.
It's because these companies have a huge potential for profit. A potential unrecognized by most investors as of now.
And you need more than a magnifying glass to go through the details of such companies to pick the winners.
Believe it or not, Equitymaster has been researching and recommending such companies for more than 7 years now.
And our subscribers have made returns like 124% in 7 months, 217% in 3 years and 11 months, 250% in 2 years and more from such little-known small companies we've recommended.
So we now invite YOU also to be part of this amazing opportunity.
Just click here for full details...
It is no secret that we endorse RBI as the kind of central bank that every economy should aspire to have. The manner in which the present and past governors of the central bank have averted one economic crisis after the other has left everyone in awe. But if we have to point out one grave error that the RBI has been neglecting for long, it is regulating the quality of management in banks. The PSU banks in particular are currently burdened with non recoverable loans of proportions not seen in years. There has been little or no penalty by the RBI on banks that have failed to sustain asset quality and protect the interest of depositors and shareholders. And now the glaring instances of fraudulent practices in several banks cast a shadow on effectiveness of the central bank.
The recent instance of fraud in Bank of Baroda, reminds us of the money laundering cases in 2013, revealed by Cobrapost. Since then, the RBI has not taken any meaningful measures to avert the growing instances of fraud. In fact by the central bank's own admission, the quantum of billions lost to bank frauds has been growing each year. And bank depositors could get increasingly nervous about the safety of their deposits without adequate action by the central bank.
Impact of bank fraud menace on economy
We keep writing about the impact of Megatrends on Indian economy. And one of the signals we had emphasised on was valued added exports especially of manufactured goods. In an interview to Economic Times late last year, ex-RBI governor Dr Subbarao revealed that according to him the first signs of Megatrend will shape up in India's engineering and manufacturing revolution. He reasoned that India needs a big manufacturing sector in order to generate jobs for hundreds of millions of people. The government too has been making a lot of noise in this regard, especially with the PM's pet project - Make in India. But as you know our review of the progress of Megatrend signals in the engineering sector and with respect to Make in India are mixed.
While the plans hold promise, the execution of reforms in the areas of engineering and manufacturing has left a lot to be desired. To add to that, global economic crisis and the Chinese slowdown has dealt a heavy blow to demand for Indian engineering products. India's engineering exports to its neighbouring countries, including China, have seen a massive fall in August 2015. And this clearly signals the demand slowdown getting all the more pervasive. Engineering exports' basket that contains steel, non-ferrous metals, industrial machinery, transport equipment, aircraft parts and others have shown a big drop of 42.9% to China. Having said that it is not just India but most emerging markets that were exporting machinery to China that have got impacted. While this maybe a temporary phenomenon, without adequate reforms in the engineering and manufacturing spaces, the early signs of Megatrend have the risk of fading.
At the time of writing, the Indian markets were trading in the green. The BSE Sensex was up by about 145 points or 0.5%. Gains were seen in engineering and banking stocks, while commodity and pharma stocks were trading weak. The midcap and smallcap indices were also trading firm.
"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - Warren Buffett
|| Today's investing mantra
Today's Premium Edition|
HUL is off 20% from its 52-week high!
Does it now make sense to pick up shares of this FMCG powerhouse?
| Get Access
|This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).
|DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS) REGULATIONS, 2014
Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.
An independent research initiative, Equitymaster is committed to providing honest and unbiased views, opinions and recommendations on various investment opportunities across asset classes.
There are no outstanding litigations against the Company, it subsidiaries and its Directors.
GENERAL TERMS AND CONDITIONS FOR RESEARCH REPORT:
For the terms and conditions for research reports click here.
DETAILS OF ASSOCIATES:
Details of Associates are available here.
DISCLOSURE WITH REGARDS TO OWNERSHIP AND MATERIAL CONFLICTS OF INTEREST:
DISCLOSURE WITH REGARDS TO RECEIPT OF COMPENSATION:
- Neither Equitymaster, Research Analyst or his/her relative have any financial interest in the subject company.
- Equitymaster's Associate has financial interest in the subject company.
- Neither Equitymaster, it's Associates, Research Analyst or his/her relative have actual/beneficial ownership of one percent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.
- Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any other material conflict of interest at the time of publication of the research report.
- Neither Equitymaster nor it's Associates have received any compensation from the subject company in the past twelve months.
- Neither Equitymaster nor it's Associates have managed or co-managed public offering of securities for the subject company in the past twelve months.
- Neither Equitymaster nor it's Associates have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
- Neither Equitymaster nor it's Associates have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
- Neither Equitymaster nor it's Associates have received any compensation or other benefits from the subject company or third party in connection with the research report.
Definitions of Terms Used:
- The Research Analyst has not served as an officer, director or employee of the subject company.
- Equitymaster or the Research Analyst has not been engaged in market making activity for the subject company.
- Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
- Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
- Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
- Sell recommendation: This means that the investor could consider selling the stock at current market price keeping in mind the objective of the recommendation service.
If you have any feedback or query or wish to report a matter, please do not hesitate to write to us.
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringementDisclosure & Disclaimer:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.
This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.
This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, the same may be ignored.
This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.
As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use
, available here. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407