Every Smallcap that Glitters is Not Gold

Mar 25, 2021

In my previous editorial, I wrote to you about the whopping 26x returns the stock of Eicher Motors delivered in a decade.

That's an unbelievable 40% CAGR!

Let that sink in...

That's the power of identifying a small cap before it becomes a darling of big financial firms.

Now that was just 1 side of the coin. Here is the other.

98% wealth destruction over a decade.

Yes, you read it right. Stocks have fallen this much over the last 10 years.

I am talking about the darlings of 2008 boom. Stocks like Suzlon Energy and Reliance Power.

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In search of the next Eicher Motors or Astral Polytechnik, chances are you may stumble upon a Suzlon or R Power.

I might have reopened some old wounds for those people who bought Suzlon at the peak of 2008 or applied for the Reliance Power IPO in 2008.

In my last article, while I spoke about how the pitch is set for small caps to fire and how we are at an inflection point.

But let me warn you...

Not every small cap stock rallying on news based momentum will create sustainable shareholder wealth.

Many of these so called 'emerging story stocks' have broken business models.

As Warren Buffet puts it 'A rising tide floats all boats. It's only when the tide goes out, do you discover who's been swimming naked.'

Learn: How to Potentially Accumulate Rs 7 Crore in Wealth Over the Long-term

Finding the next Eicher Motors or Astral Polytechnik in this BAAP (Buy At Any Price) market will need the eye of an eagle.

It's imperative we distinguish between a good quality value buy from a momentum value trap. After all, nobody wants to be left with a Suzlon or a Reliance Power in their portfolio.

Just look at the frenzy in the IPO market.

Subpar Performance from Majority of IPOs Compared to Their Listing Price

Company No of times
HNI subscribed
LTP Listing day close % Change since listing
MTAR Technologies 651 1055 1082 -2%
Mrs Bectors Food 621 344 595 -42%
Chemcon Speciality 449 422 584 -28%
Easy Trip planners 382 184 208 -12%
Burger King 354 137 138 -1%
Herenba Industries 271 643 750 -14%
Indigo paints 263 1765 3118 -43%
CAMS 112 1870 1401 33%
Home First Finance 39 453 527 -14%
Stove Kraft 33 471 445 6%
Antony Waste Handling 19 268 407 -34%
Source: Equitymaster

Not everything that goes up is a quality stock.

Many of the companies in the above table listed at astronomical valuations. They have seen a decent correction.

Let us use an upcoming IPO to understand the euphoria in the IPO market.

Fact 1: Barbeque Nation allotted shares on a preferential basis to Jubilant Foods in a pre-IPO placement at Rs 252/share in January 2021.

Fact 2: Barbeque Nation comes out with an IPO at a price band of Rs 498-500/share in March 2021.

Fact 3: Unrelated to the above 2 facts; Barbeque Nation is a loss making company.

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Are we missing something here in terms of valuations? What has changed over the past 2 months that the valuations have doubled?

The above narrative was to substantiate my point not all that glitters is gold.

I believe as the recovery in the economy broadens, it's the unloved and shunted sectors of the past decade that will bounce back sharply.

After all, 'What doesn't kill you makes you stronger'.

In this context, sectors such as real estate, building materials, capital goods, infrastructure and power to name a few will be the beneficiaries of broad based economic growth.

Again, the key is to find quality small caps in these sectors.

In my next article, I'll decode specific stock opportunities for you.

Warm regards,

Aditya Vora
Aditya Vora
Research Analyst, Hidden Treasure

PS: If you want to invest in the best smallcaps in the market today, Richa Agarwal, editor of Hidden Treasure, has the answer. Click here to learn more...

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