X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Should one be careful about these small caps? - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Apr 19, 2012

    Should one be careful about these small caps?

    From a year ago, India's benchmark index, the BSE-Sensex has fallen by about 9% YoY. During the same period, the BSE Mid Cap and BSE Small Cap indices have declined by about 9.5% and 21.1% respectively. It is very evident that smallcap stocks have underperformed their larger peers significantly. With macro factors not really going in the desired direction and the future scenario being uncertain for a while now, stocks of smallcap companies have not found favor.

    However, as is always the case, many stocks outperform the broader indices. And for a case when the broader index, the BSE-Small cap index in this case, has declined so sharply, a smallcap stock doubling is a quite a big deal.

    In this article, we will be looking at some of the stocks have outperformed the broader indices significantly, but at the same time, their fundamentals do not seem to be in place.

    You might think of us as party-poopers, but given the value investing principles we follow, it would be best to go back to basics of fundamental analysis and judge for yourself.

    We have collated a few data points for you to gauge - latest P/E ratio; stocks returns over the last one year; 5-year return on equity and their average; and the latest report debt to equity ratio of the company. All these data points, we believe, are amongst the key parameters that one must consider before investing from a long term perspective - especially for stocks from the smallcap space.

    The list we have collated is as follows:

    Company Latest P/E Returns # ROE (L-4) ROE (L-3) ROE (L-2) ROE (L-1) ROE (L) Avg. ROE D/E (L)
    Blue Circle Services Ltd. 570.5 1738.9% 0.1 0.0 9.6 9.2 7.8 5.3 0.0
    KSL & Industries Ltd. NA 421.0% 11.4 11.0 5.1 0.8 -0.7 5.5 2.2
    Banas Finance Ltd. 690.6 249.1% -11.8 -16.1 -15.6 2.8 1.2 -7.9 0.0
    Ram Kaashyap Investment Ltd. NA 239.9% -6.9 2.1 1.5 3.4 6.2 1.3 0.5
    Saint-Gobain Sekurit India Ltd. 59.2 128.5% -19.1 -0.2 0.6 9.5 16.5 1.5 0.0
    Visagar Polytex Ltd. 371.8 96.9% 90.7 72.6 17.7 9.3 8.8 39.8 0.4
    Industrial Investment Trust Ltd. 84.3 82.4% -24.7 21.2 7.6 18.2 4.9 5.4 0.0
    Advanta India Ltd. 57.3 72.9% 43.3 4.8 2.0 -9.9 -7.8 6.5 1.3
    Unisys Softwares & Holding Inds. Ltd. 253.3 65.7% 0.0 0.0 0.1 0.3 3.6 0.8 0.0
    Forbes & Company Ltd 163.2 45.6% 3.5 1.0 -28.3 -8.9 0.4 -6.4 0.8
    The Byke Hospitality Ltd. 109.1 41.8% 30.5 23.2 4.0 3.0 4.7 13.1 0.0
    Sayaji Hotels Ltd. 225.5 36.2% 13.9 14.0 10.0 -0.6 4.3 8.3 1.4

    Data Source: ACE Equity; # - Returns over a period of one year; NA - not applicable; D/E - Debt to Equity ratio

    It must be noted that in the table 'L' stands for latest available data, while L-1 is the data for one year prior and so forth. In addition, the data shown in the table is for the standalone figures.

    As you can see, certain parameters of these stocks would make one stay away from such kind of companies. High valuations, deteriorating return on equity (the ultimate figure that every investors looks for) and high debt levels are all factors the make a company fundamentally weak. Profit growth should not be looked at in isolation.

    Whether these stocks will further move up from here (or decline sharply, for that matter) is difficult to say. But all we can conclude is that companies with such poor fundamentals do not deserve valuations such as what they are garnering at the moment. In fact, even some of the best quality, fast growing companies do not command such high valuations!

    A lot of weight needs to be given to qualitative aspects, which should all be looked at in conjunction with one's stock picking process. These include: Company's management for its competencies, execution skills and integrity; company's standing in the industry given the fact that small-sized companies are the first to buckle under pressure in case of a downturn; a solid financial performance history; and the quality of earnings.

    And not to forget, the final icing on the cake - valuations! While valuations differ with various companies (depending on their quality of earnings), ideally, the highest valuation a company deserves should not exceed the high teens. And for the valuations approach towards smallcaps, one should be all the more careful given their higher volatility levels as compared to their larger peers.

    While aspects such as ideal P/E multiple is a topic for discussion for another day, investors - before purchasing a stock - must ask themselves these questions before purchasing a stock:
    • If I buy the stock at x times multiple, at what pace will its earnings have to grow?

    • Is such growth possible given the historical average margins and growth rates?
    In the words of one of the most celebrated investors in the world, Peter Lynch - "If you remember nothing else about p/e ratios, remember to avoid stocks with excessively high ones. A company with a high p/e must have incredible earnings growth to justify its high price."

      Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.

     

     

    Equitymaster requests your view! Post a comment on "Should one be careful about these small caps?". Click here!

      
     

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Will They Haul Off Trump's Statue, Too? (Vivek Kaul's Diary)

    Aug 16, 2017

    All across the country, the old gods become devils. New, gluten-free gods take their places...

    This Company Beat the Business World's 'Three Killer Cs' (The 5 Minute Wrapup)

    Aug 16, 2017

    And what it has in common with beating the stock market too.

    5 Steps To Become Financially Independent (Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    Let's Hope This Correction Continues (The 5 Minute Wrapup)

    Aug 14, 2017

    Last week's correction is making a number of Super Investor stocks look a lot more attractive...

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    Proxy Plays: A Smart Way to Bet on 'Off Limits' Companies(The 5 Minute Wrapup)

    Aug 4, 2017

    The small-cap space is full of small players that are clear proxies to great growth stories and Indian megatrends.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    More
    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 infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. 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: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE SENSEX


    Aug 16, 2017 (Close)

    MARKET STATS