Smallcaps: How have they performed? - Views on News from Equitymaster

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Smallcaps: How have they performed?

Aug 28, 2008

What is the Smallcap Index?
The indices in general are constructed on the 80-15-5 method, wherein companies aggregating to approximately 98.5% of average market capitalization are categorized under large, mid and small cap segment respectively from the BSE universe. The BSE Smallcap Index tracks the performance of scrips, which contribute to almost 5% of aggregate market capitalization of all the companies, listed on the BSE. The constituents of the index are reviewed every quarter. As on 14th July 2008, 488 companies constituted the BSE Smallcap Index.

Performance over the years
If one had invested Rs 100 each in the BSE-Sensex, BSE 500 Index and the BSE Smallcap Index in April 2005, it would be currently worth Rs 226, Rs 206 and Rs 178 respectively. We can notice from the above chart that the BSE Small cap Index has garnered higher returns at the peak of the bull runs as compared to the other two indices. During the two bull run peaks (circled), we can notice that the returns from the Smallcap Index were higher as compared to the returns from the other two indices. However, post the market corrections in mid 2006 and January 2008, these 'high' returns have literally tanked.

The question that would come to everyone's mind is what could be the reasons behind this behaviour of the small cap index. Since a definite answer cannot be given on account of the complexities involved, we can only hazard a calculated guess. First, investors prefer to invest in stocks that are well researched and whose information is widely available. The list of these stocks would largely consist of large cap stocks. During a bull run, once these large cap stocks tend to get expensive or over valued, investors begin to search and locate for cheaper or 'value stocks'. Thus targeting the companies from the midcap and smallcap space.

Conclusion
Share prices are nothing but indicators of an investor's expectations of a company's future earnings. But this rule may not always apply to the companies from the BSE Small cap index. Agreed, that the growth potential of these companies is much higher as compared to the larger players, however, more often than usual, stocks in the BSE Smallcap Index move on the basis of the market sentiments rather than on their fundamentals. Investing in stocks from the smallcap space may not be everyone's cup of tea. Investors must be well aware of the business and industry of the companies they plan to invest in, as the chances of failures are high.

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