Smallcaps Are Set for a Massive Rerating...

Editor's Note: Join our smallcap guru, Richa Agarwal, online, at the Smallcap Revival Summit at 5pm today. Richa will share details of her top 3 smallcap recommendations.

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Two days ago, I released an update on open smallcap positions in Hidden Treasure, my smallcap stock recommendation service.

Amid the second covid wave and lockdowns, smallcaps have touched 52-week highs.

The BSE Smallcap index gained 7% in a month. The gains in individual smallcaps are even higher.

In the open positions, almost 18 smallcaps we recommended gained over 10% and more.

And four of these were up 30% or more in a month.

That's what a rebound can do to stocks with lower marketcap and relatively low liquidity.

From January 2018 to March 2020, when smallcaps were in a bearish zone, we decided to not resort to stop loss limits.

We recommended holding on to stocks with strong fundamentals and an impending turnaround.

While we did not expect a 100% success ratio, we were confident about the process that helped us beat Sensex over 2 times for more than a decade.

And our patience has been rewarding.

But the current rally in smallcaps begs some questions.

From January 2018, after touching a high of 20k, the smallcap index crashed by over 50%.

We are well past those levels in the current rally. One might be rightly concerned if this would be a level to exit.

While we have booked profits on some stocks, we are also holding on to existing and potential big gainers.

I believe that there is more fuel in this rally. Here's why...

Keeping fundamentals aside, which I'll come to in a bit, the rebound in the smallcap index at 157% is way below past rebounds which have ranged from 210% to 293%.

There's consolidation happening in the smallcap space. The survivors and resilient players are not just see fundamental upside but are also likely to get rerated.

But there is more to stock markets than smallcaps.

And it will be good to see how different stock classes are stacked against each other.

Over the years, I believe smallcap to Sensex ratio is a good metric to gauge while coming to some conclusions about relative valuations.

So what does this indicator suggest?

As you can see from the chart, the ratio currently stands at 0.46 times, as compared to long term average of 0.43 times.

In the last one year, the smallcaps have done well to cover the gaps with the large peers.

But it could be premature to call this a peak.

In the previous two rounds, the average ratio has been 0.57, suggesting more upside from these levels.

And that's just the index.

There are individual small-cap stocks where the valuations remain attractive, and potential gains could be even higher.

In January 2018, when smallcaps peaked, midcaps, and large caps accounted for 88% of the total market cap.

At present, the share of midcaps and large caps is at 92%. The allocation to smallcaps remains in single digits.

As I shared in a recently in the Profit Hunter, largecap and midcap companies are valued at a P/E i.e. price to earnings ratio of 28.4 times. The Sensex is commanding a PE of over 30.

Value Stocks: Stocks with Limited Downside but Good Upside Potential

In comparison, despite a 150% run up, the P/E ratio for smallcaps in this list stands at 16.3 times.

The search for alpha i.e. outperformance over the broader market, is likely to keep smallcaps in favour.

Coming to the fundamentals....

In the last two years, there has been a lot of clean up in the corporate balance sheets of small companies.

There has been a reduction in the debt. The cash flows are looking better.

And even amid the ongoing chaos, better placed smallcaps are posting their best ever quarter in terms of performance.

The liquidity in the system, which is a life blood for growth of smallcaps, is back after getting wiped out post IL&FS crisis.

And the capex plans that were put on hold are being carried out. The smallcap managements with a good track record of capital allocation and execution are likely to create huge value for all the stakeholders.

I believe the current rally is not just a cyclical phenomenon but backed by improving fundamentals and consolidation among smallcaps.

But after that recent runup, nothing is dirt cheap.

Finding a perfect combination of strong fundamentals, good management, and margin of safety, needs lot more work than running a screener and riding big themes.

It's time to be selective.

For such select stock opportunities in smallcap space, join me online at 5pm this evening at the Smallcap Revival Summit.

I'll show you exactly how to profit from the upcoming massive revival in smallcaps.

Sign up for summit for free.

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure

PS: Join me online at 5pm today at the Smallcap Revival Summit. I'll share details of my top 3 smallcap recommendations.