How to Pick Tomorrow's Smallcap Winners Today

Feb 8, 2022

How to Pick Tomorrows Smallcap Winners Today

Last week, I shared my views on the market in context of the Union Budget.

Actually, it's not right to put it this way.

I avoided sharing any view on the market or reaction of the market in response to the Budget.

And I shared why it doesn't make sense to let sentiments weigh on your long-term investing decisions.

If I came across as a clueless analyst, I assure you that's not the case. I've been tracking the Indian stock market for more than a decade. And it's only with experience have I realised how futile that exercise it.

I may not know what markets will do next week, next month or even next year. But I'm reasonable comfortable sharing the direction and milestones of the markets 5-10 years from now.

So here's my view...

The Sensex could be close to 200,000 by the end of this decade.

How did I arrive at this number?

The average annual earnings growth for the Sensex stands at 15.4% CAGR for last two decades. And the index has traded at a median price to earnings (PE) ratio of 19.9 times.

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Extrapolating the growth rate and the PE multiple 4 years from now, the Sensex could touch 110,000.

Now extend the timeline a little more with the same averages. And by the end of the decade, and the Sensex value comes out to 195,000.

So what does this mean for smallcaps?

The long term smallcap to Sensex median stands at 0.43 times (the previous peak was 0.58 times).

So under a base case scenario, the smallcap index could touch 47,300 four years from now. Extending the same logic, by the end of this decade, the index could be at 83,850.

And I'm not even factoring in the growing participation of retail investors, which could be another driving force.

What about the potential of good businesses in the smallcap space?

Here's another stat for you.

36% of the stocks in the midcap index today, belonged to the smallcap index 10 years ago. The key is to find smallcaps with the potential to be future midcaps or even largecaps.

This is not going to be easy in the current market. Despite the recent volatility, a lot of companies, across marketcaps, are trading at puffed up valuations.

A savvy investor will have to differentiate the future winners from cyclical businesses (the ones that will correct or reverse downwards to mean).

In fact, it might make some sense to book profits in the cyclical businesses while you still have the opportunity to take the profits off the table.

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And speaking of future winners, you will need to focus on two important aspects.

  • Businesses with strong structural tailwinds

    These tailwinds could be a result of digitisation of the economy, i.e. the shift in global supply chains - Think of Indian textile companies benefiting from China plus one.

    It could be some kind of optionality in the business that markets have not factored in yet - The next Info Edge?

    A technological edge - For example, the only plastic packaging company that offers QR code solutions that allows traceability and minimises adulteration and counterfeiting.

  • Managements with competence and execution

    It's not enough to check for qualifications, growth in the business or even experience. Invest in managements you can trust to act in the best interests of minority shareholders.

    It's relatively easier to assess the managements of companies that have been in public for a long time. For the new age companies that have just listed, both the business models and the managements will have to pass the test of time.

    You can't just rely on the due diligence of a few big PE or VC investors that have been a part of their journey. Nor you should get carried away by the halo surrounding the founders.

    The controversy in BharatPe is a case in point. Had the company been listed, the valuations would have taken a knock and given retail investors another shock.

Remember these words...

  • You're looking for three things, generally, in a person: intelligence, energy, and integrity. And if they don't have the last one, don't even bother with the first two. - Warren Buffett

Now having shown you the promise the Indian equity markets have, here's another thing I'm sure of.

This upward journey will not be unidirectional.

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There will be sharp corrections in between that you won't be able to predict or dodge.

For instance, if you could have predicted the Covid crash and the persistence of the virus ahead of anyone else, you would have taken all your money out to before March 2020.

In that case, you would have missed the huge upside of the post Covid runup.

By the way, when I was writing this piece yesterday, the Sensex fell by over 1,100 points. And who knows where the market will be today when you're reading this.

If you are obsessed or spooked by these daily corrections or volatility, long-term investing is not for you.

Also, the volatility could turn into a huge risk if you haven't followed a prudent allocation strategy.

The journey to huge long term returns will have days or months or may be even years when your investments will lose money.

If you lose your conviction based on stock prices, you will forego the chance to make huge returns. You could end up losing money too.

A case in point is the smallcap index...


The smallcap index is up 340% in last 10 years. On a CAGR basis, this is a return of 16%.

Now look at all the troughs it has been through.

In the most brutal correction from January 2018 to March 2020, the smallcap index was down 56%.

And this correction lasted more than two years!

It's also worth mentioning here that for the last decade, its most impressive performance has been in the last two years when the index has more than trebled.

Speaking of specific stocks...

One of the biggest post Covid rally gainers in my Hidden Treasure's open positions, is up over 600% in four and a half years. But it was down 46% at one point from the recommendation price.

My point is: You cannot reach the peak without having a capacity to suffer.

So focus on long term business quality, the quality of the management, and risk management (asset allocation and margin of safety in valuations).

And there will be a good chance the smallcap you pick today grows to be a future midcap.

Happy investing!

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure

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Revealed: The 5-Minute Blueprint for Potentially Becoming a One Stock Crorepati

At our One Stock Crorepati mega summit, Richa revealed the 5-minute blueprint for potentially becoming a One Stock Crorepati.

Richa also revealed the 3 traits of what she calls a potential crorepati stock.

Plus...she also revealed details of a tiny company that has all these 3 traits.

You too had signed-up for Richa's summit. But you missed it for some reason.

No worries. You can still watch the special replay of the summit to get all these details.

Learn more

Equitymaster requests your view! Post a comment on "How to Pick Tomorrow's Smallcap Winners Today". Click here!

1 Responses to "How to Pick Tomorrow's Smallcap Winners Today"

Janardan Mohanty

Feb 8, 2022

One loss making company is actively recruiting manpower. Is it heading for sharp turnaround?
Future Lifestyle Fashions Limited.

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Equitymaster requests your view! Post a comment on "How to Pick Tomorrow's Smallcap Winners Today". Click here!