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Stockmarkets: Looking for big gains? - Views on News from Equitymaster
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  • Aug 18, 2004

    Stockmarkets: Looking for big gains?

    The index movements have been rather apprehensive and relatively inactive over the last one-month with most of the Indian indices (i.e. BSE-Sensex, BSE-100, BSE-200 and BSE-500) trading in a range (up 3%) despite the largely positive perception towards the India growth story. While the apprehensions are related to the adverse impact of higher interest rates, which are dependent on inflation, which in turn are dependent on crude prices, which are trading at record highs, the relative inactiveness actually should be taken in a positive sense. This is because indices across the globe have taken a beating during this period, while Indian stock markets have showed some resilience.

    However, the calmness of the indices does not reveal the true picture. This is because the action outside of the indices over the past month has been rather strong, which can be also gauged from the table below.

    Top gainers in the last one month
      % gains
    BSE-30 3.1%
    BSE-500 3.4%
    Balaji Telefilms 56.2%
    MRF Ltd. 46.1%
    GMDC 36.3%
    CMC 35.1%
    Orchid Chemicals 31.0%

    It is numbers like the above that can easily entice investors to invest in such stocks (largely small and mid-cap) and more often than not, these are the stocks, which are mostly low-researched (or sometimes non-researched) and where the speculation activity is at its maximum. But investors tend to assume that they have the capacity to ride the rally in these stocks and make a quick buck. However, what happens in reality is something totally different.

    More often than not when investors do invest in small cap stocks, it is co-incidentally the time when the rally in these stocks stand terminated and small investors are caught on the wrong foot. Moreover, don't be surprised as on a number of occasions, the gainers this month could be the top losers over the next few months and the downside for these could be then unlimited owing to missing fundamentals. In fact, now in hindsight, on making a random check of the 'top losers' in the last one month, investors should note that many of those stocks were amongst the key gainers in the prior months thus indicating the intense volatility in these stocks, which not only affects investors nerves and faith in equities but also is detrimental to his portfolio capital.

    However, the above is just one side of the story. Advocates of the small and medium-cap investment ideas would argue that the growth potential of smaller companies is much larger than larger companies, whose businesses are at the maturity stage. While we are not against investing in mid-caps and we do agree to the above argument, we, however also feel that smaller companies have a relatively higher chance of failing, which could either be, among many reasons, due to their lack of experience or limited financial support to ward off competition from the biggies, thus making their futures rather fragile.

    Nonetheless, while we do agree that smaller stocks could become potential winners in the medium to long-term, it is to be noted that there is a high risk premium attached to investing in such stocks. And to mitigate the higher risks, the most important point here is that no investment should be considered in any stock that is not well researched. Further, it must be noted that strong fundamentals, viable business model and trust worthy management are amongst the key ingredients that go into making a strong research.

    Further, considering that access to information about smaller companies is rather difficult for small investors, they could look at investing through mutual funds, which is under the supervision of professionals. This would also take care of the volatility concerns related to small and mid-cap stocks. However, for investors who are relatively risk-averse and for whom capital protection is of prime importance, it is safer to stick to liquid, large capitalization and fundamentally sound companies instead of investing in 'emerging mid-caps'. Thus, to conclude, ultimately, investors will have to choose between the tradeoff of risk and return.



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