Aug 30, 2010|
Do smallcaps = large profits right now?
In our previous article, we discussed whether midcap stocks seemed to look attractive at this point in time. We used the BSE-Sensex as a benchmark for the same. This time we will be discussing whether the BSE-Smallcap index seems overvalued or undervalued. There are over 500 stocks in this index, which is almost twice the number in the mid-cap index and 18 times the number in the Sensex. Although this is a large universe to choose from, a large majority of them are virtually unknown. But, some are household names including Fame India, Spicejet, Moser-Baer, Provogue etc. Let us now see, how they have been performing on a collective basis.
The BSE-Sensex is just around 17% short of its historical highs, seemingly overvalued. Let us now see what this indicates for the smallcap stocks, whose representative index (the BSE-Smallcap Index) is benchmarked against the BSE-Sensex?
Below we have displayed a comparative data for both the indices – BSE-Sensex and BSE-Smallcap index.
| Data Source: CMIE Prowess
If one had invested Rs 100 at the beginning of 2008 in the BSE-Sensex and the BSE-Smallcap indices each, it would have been worth Rs 90 and 72 respectively. This indicates that the Sensex has outperformed the BSE-Smallcap Index over this two and a half year period. However, the BSE-Smallcap Index has by far outperformed the BSE-Sensex over the last year (2009) as well as during the year till date (YTD; January 1 2010 to August 24 2010). While the BSE-Sensex has risen by 17% over the last year, the BSE-Smallcap Index has risen by 49%. As for the YTD comparison, the BSE-Sensex is up by 5%, while the BSE- Smallcap Index is up by 18%. As we saw earlier, the BSE-Midcap index was up 17%, showing that their performance was more or less in line.
However, the best way to gauge the attractiveness of stocks is to look at their price to earnings ratio (PE). This helps shows if the run up in stock prices is justified viz-a-vis an increase in earnings or profits to shareholders. The same works for analysing an index, which is basically a collection of stocks. A good way to gauge the same is to compare the valuations of the BSE-Smallcap Index with the benchmark index, the BSE-Sensex.
Below is a chart indicating the PE ratios of both the indices since 2008. We have also shown the average PE ratios of both these indices during this two and a half year period (prior period data was not available at this time). While there is no doubt that the BSE-Smallcap Index would trade at lower valuations as compared to the BSE-Sensex (for multiple reasons), the main question is that despite this, are smallcaps attractive at this point in time?
| Data Source: CMIE Prowess
We shall look at the next chart to find out. Below is a chart displaying the difference in valuations over this period. We have calculated the same by dividing the PE ratio of the BSE-Sensex by the BSE-Smallcap Index.
What does this chart foretell? Well, as the ratio moves towards the 1 times mark, this means the difference in the PE ratios of the two indices is less. This could mean two things – Either that the Sensex is undervalued or that smallcaps are expensive. What we can also learn from this is that the market is pricing midcaps as well as smallcaps similarly. This is despite the fact that smallcaps are supposed to be more volatile.
| Data Source: CMIE Prowess; *Average period considered as Jan 2008 till date
Similarly, when the ratio drifts away from the 1 times mark; this could indicate that the BSE-Sensex is expensive or that the smallcap stocks look fairly attractive.
What does it indicate at this juncture?
Well, considering that the BSE-Sensex is trading at a price to earnings of about 21.8 times, it seems to be a tad on the expensive side (as compared to its long term average valuation of about 16 to 17 times). The BSE-Smallcap Index's valuations seem to be close to the 1 times mark, indicating that smallcaps (as a whole) also seem to be 'not so attractive'. Since, they trade at a slight discount to midcap stocks, it seems that both indices, on the whole seem to be fairly valued at this point. This means that most of the upside is already priced in.
More Views on News
Jul 14, 2016
Tata Consultancy Services (TCS) has declared results for the quarter ended June 2016. The company has reported a 3% QoQ increase in consolidated sales while the consolidated net profit was up 0.3% QoQ.
Jul 8, 2016
Tata Motors Ltd has reported a 19% YoY and 202% YoY growth in sales and net profits for the quarter ended March 2016.
Jul 4, 2016
Idea Cellular has reported a 12.4% YoY growth in the topline and a decrease of 0.4% YoY in the bottomline for the quarter ended March 2016.
Feb 24, 2017
If you are seeking that extra return and do not mind the short-term volatility, then opportunity funds are for you.
Feb 24, 2017
Why does the US economy stagnate? Because fewer people are learning. The zombies don't have to learn. The cronies learn the worst lesson of all: that crime pays.
More Views on News
Feb 11, 2017
A wealth-building strategy is more than just about how to pick good stocks.
Feb 14, 2017
Apurva closed a trade with gains of 18.24% for his Swing Trader subscribers. But he's not happy about it. Find out why.
Feb 21, 2017
Why buybacks may not always be a tempting proposition.
Feb 15, 2017
The investors are writing down their investments in these firms.
Feb 21, 2017
Will the proposed buyback change the fortunes of TCS?
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. Use of the information herein is 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 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: +91-22-6143 4055. Fax: +91-22-2202 8550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407