How to Spot the High Potential, Lesser Known Smallcaps

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You know things are headed the wrong way when regulators have to flash warning signals to the custodians of our money.

Something similar happened in the Indian markets recently.

The Indian stock markets, especially small and midcaps have witnessed a sharp rally.

At 0.62 times, the smallcap to Sensex ratio beats the median of 0.43x by a wide margin, and also the previous peak of 0.58, that was followed by a sharp correction.

You would expect most institutions dealing in retail money to exercise caution in these times.

But that's hardly the case.

Despite high valuations, more schemes have been launched in the small and midcap space to make the most of the greed in this space.

No wonder then, AMFI and the market regulator had to step in. They have told asset management companies to have checks and balances to safeguard small investors. This includes limiting inflows and portfolio rebalancing.

Now, there are thousands of listed stocks in mid and smallcaps, so why are regulators worried?

The reason is - over 90% of these inflows find way to just a few hundred stocks. The rest remain below the radar of funds due to issues like limited liquidity to absorb huge fund flows.

You know how this situation turns out.

When too much money flows into smallcaps with relatively low marketcap and liquidity, the PE multiple expands. However, this rerating is just driven by money, and not business performance.

So, while this could inflate the valuations of a limited set of stocks for a while, in case of any shock or negative news, the derating could be equally sharp, and the exit in these small-cap stocks could be stretched.

In the meantime, don't be surprised if the notional gains turn into losses in a matter of few days.

So, how could you participate in this rally without getting butchered.

I believe it will require avoiding a beaten down path and taking a road less taken. Instead of following what smart investors or institutions are buying, be deliberate in looking for high potential undiscovered stocks.

This way, chances are you would benefit from not just the growth in the business (from a low base) but will position yourself well to ride the rerating gains. And I'm not even counting the bragging rights when you are ahead of smart investors in picking multibaggers.

But this is not as easy as it sounds.

There are thousands of such unknown stocks. And most of these will remain unknown throughout their lifecycles.

In order to ride a multibagger, you would need to combine low liquidity stocks in a business with huge opportunity, and with the backing of a strong management team.

Today, I want to highlight one such candidate. It grabbed my attention due to recent insider buying in the stock.

With a marketcap of barely Rs 5 bn, High Energy Batteries (India) Ltd manufactures batteries that are used in defense and aerospace (launch vehicles), cars, CVS, and trucks etc.

It has the capabilities to design and manufacture batteries for mission critical platforms like torpedoes, fighter aircraft, supersonic missiles, army battle tanks, unmanned aerial vehicles, autonomous underwater vehicles, and satellite launch vehicles (SLVs).

Besides, it is working on areas like fuel cells where hydrogen could be used as a fuel and pursuing opportunities in energy storage systems as well.

It claims to be the only supplier of silver-zinc batteries to the Indian navy, with a market share between 65-70%. It also supplies nickel cadmium cells to the defence sector.

In fact, it has produced batteries for PRITHVI, AGNI etc., and for all the three variants of BrahMos and remains a key beneficiary of Make in India scheme.

Its clients include Naval Science & Technological Laboratory, Advanced System Laboratory Dte. General of Naval Armament, Brahmos Aerospace Pvt. Ltd, and Bharat Dynamics Ltd. The debt on the balance sheet is minimal.

The return ratios are above 30%. The cash flow from operations has been consistently positive in last five years.

Like I mentioned earlier, the stock has seen strong insider buying in 2024.

All this is not enough information to have a view on the stock or to make a recommendation.

The business has some inherent risks like overdependence on the defence sector, and an intensive working capital cycle.

Nonetheless, it is a strong candidate for a watchlist of high potential, lesser-known stocks.

For more such underexplored opportunities, watch this space...

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure