Your Ride to the Next Eicher Motors Begins Here

Mar 18, 2021

Do you know what is common between Astral Polytechnik and Eicher Motors?

These 'midcap darlings' of the stock market today, were 'tiny microcaps' two decades ago.

And how they have evolved!

Not many could have thought, CPVC pipe technology (which was 30% costlier at that time) could replace Galvanized Iron (GI) pipes, the norm in the piping industry.

Only a few investors were ready to bet on a disruptor like Astral.

But the company went a step further and did the unthinkable. It successfully created a brand out of a commodity: pipes. No wonder it enjoys the price to earnings ratio of a FMCG company.

Or let's consider Siddharth Lal. This young entrepreneur was given a deadline by the board of directors to turnaround the loss making Royal Enfield.

He did.

Royal Enfield sales went up from 50,000 bikes per year to more than 50,000 bikes per month currently!

What a great brand following and cult Royal Enfield has created for itself...

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Let's do some fun math on Royal Enfield.

A Royal Enfield bike purchased in 2010 would have cost you Rs 84,000. The same amount put in Eicher Motors stock would have fetched you Rs 23 lakh!

A whopping 26x returns in a decade.

With that much money you could not only go bike riding to the Himalayas but also purchase a house in the hills.

That's the power of investing in small-cap stocks.

But why am I giving you this analogy?

I am sure after the ruthless slaughter of small and midcaps in 2018, you folks would prefer sound 15% compounders.

Our minds are programmed to like consensus stocks. The herd investing mentality makes overvalued stocks look safe.

And why not? After all safe is good, right?

Well, in that case let me make a compelling case for smallcaps.

Here are straight points backed by data. No theories or conjectures.

In a slowing economic growth scenario, the strong (largecaps) gets stronger while the weak (smallcaps) wither out.

Alert: Discover Richa's Top 3 Stock Picks for 2022...

When the economy faces headwinds it's the strong companies (large-cap stocks) which gain market share. That is exactly what happened post 2016.

After all, stock prices are slaves to earnings. The GDP growth rate post 2016 has been on a downward trajectory. The same has been mirrored in smallcap returns post 2016.

Demonetisation and GST coupled with the IL&FS crisis had their part to play in slowing the growth of small and medium enterprises. On the positive side, it also made sure the fittest survived.

Now This phase is set to change.

With economy bottoming out post the covid induced recession, I strongly believe small-cap stocks are likely to make a comeback. Broad based economic growth will propel the next set of smallcap disruptors.

If you don't believe me, consider what happened during 2003-2007 era.

While the economy grew at CAGR of ~ 9% during the period, Nifty grew 3.5x.

Here comes the big one, small cap index was up 6 times during that period.

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Let's talk about valuations, just like stocks are slaves to earnings, valuations are slaves to fund flows.

While the broader stock market lagged earnings growth in a slowing economy, it were the leaders who dominated the show.

And rightly so as they gained market share and thrived at the expense of number 3 & 4 players in their respective industries.

This led to money moving out of smallcaps to largecaps. The result was too much money chasing too few stocks.

But as I mentioned, things are about to change.

About 20-30% of small-cap stocks are still below their peaks of 2017.

Valuations in large cap stocks have hit the ceiling. It's time for the broader market to pick up as earnings pick up.

Also a compelling case for investing in small cap stocks are macro factors such as interest rates. Imagine a small cap company paying interest on borrowed funds at 8-9% in 2017-2019.

Thanks to the folks at RBI, interest rates have gone down by at least 2-3% if not more.

Small companies are able to refinance their debt at much lower levels. This will lead to higher profits going forward.

Higher profits = Higher share prices.

That's why I say catch them young!

Warm regards,

Aditya Vora
Aditya Vora
Research Analyst, Hidden Treasure

PS: Richa Agarwal our smallcaps stocks editor, recently spoke about the best smallcaps in the market today at the Smallcap Fortunes Summit. Watch the video of the summit here.

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