The Perfect Smallcap for Uncertain Times

Editor's note: At 5 pm this evening, I'll reveal my 5-minute blueprint to become a One Stock Crorepati. Book your free seat here.

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'You are so risk averse. How can you beat the markets in the smallcap space?'

This was a question my friend asked me when I suggested to postpone early bookings for a Euro trip considering the news coming out about monkey pox.

As an analyst, I look at the smallcap space, where risks are inherently high. So people often jump to the conclusion that I recommend risky stocks, or that I like taking risks.

The reality is quite the opposite.

I know it's a volatile space with inherently higher risks. So I'm extra cautious and choose stocks with enough stability and margin of safety.

It doesn't always lead to a 100% success ratio. But a cautious approach and a prudent asset allocation allows us to beat the benchmark indices over the horizon period of 3 to 5 years.

These are uncertain times... for the economy, and for the stock market.

We have the Russia-Ukraine war, inflationary pressures, and rate hikes that could be short term deterrents to optimistic growth projections.

With rise in interest rates and the FIIs exodus, you should be prepared for volatility in the stock market as well.

As I recently wrote to my subscribers, this is neither the time to be fearful, or greedy... it's the time to be highly selective.

Allow me to explain...

Why it's Not the Time to be Fearful

The chart above is the Smallcap to Sensex ratio.

Despite the sharp rally in smallcaps, the ratio is 0.47 now.

At this level, it's closer to the long-term median of 0.43 to 0.44, than to the previous peak of 0.58 in January 2018, or the higher peaks earlier.

I believe that in the long term, and within this decade, there is a potential for Sensex to touch 1 lakh.

At median, this would imply 43,000 for smallcap index, versus 26,384 now. The individual smallcaps could fetch gains much higher than the index.

But that doesn't imply you should throw caution to the wind.

Like I said, there are economic challenges. As the excess liquidity gets drained out, corrections and volatility in the smallcaps could be sharp, in the short term.

In fact, the smallcap index has already lost 15% since the start of the year.

Supply chain bottlenecks, inflationary pressures, salary hikes, high attrition rates are some of the factors that have led to a muted performance in the latest quarter.

It's likely these challenges will remain for at least the next two quarters, from whatever we know now.

Tough times won't last, but businesses will. These will be the times for businesses with the capacity to suffer to emerge stronger.

Businesses across industries will undergo a consolidation phase, with weaker players getting pushed out.

Here's what these businesses look like:

• Businesses that are critical for their clients in the B2B (business to business) segment and to their customers in the B2C segment.
• Businesses that are continuously working on adapting to the solve the pain points of customers and doing that without burning themselves.
• Businesses that are not just price takers but have the ability to pass on prices and maintain, if not increase, per unit profits.
• Businesses that are continuously exploring optionalities with new markets, new segments, and technologies, and doing so while taking the margin trajectory upward.
• Businesses where the management has skin in the game and a track record of treating the minority shareholders well.
• Businesses with strong balance sheets and strong returns. Growth is virtuous only if it yields returns higher than the cost of capital.

These businesses are not often easily available, at least not at the prices with enough margin of safety.

However, the good news is with the recent correction in smallcap space this has changed a bit.

Some of these businesses have entered the affordable zone after a long time. They're providing a good opportunity for investors to enter at attractive valuations.

I'll be talking about one such business today at 5 pm at my One Stock Crorepati Summit.

It's a company I have been tracking for a long time. My conviction has grown over time with management successfully executing on all their growth plans.

Not only has the business grown in good and bad phases of the economy, but it has also done so while improving returns and making the balance sheet stronger.

And that's why I recommended an allocation higher than what I typically do for smallcaps.

So make sure you do not miss this big event. The buying opportunity may not remain open for long.

Join me online at my One Stock Crorepati Summit today at 5pm. Reserve your free seat here.

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure

PS: At 5 pm this evening, I'll reveal my 5-minute blueprint to become a One Stock Crorepati. Book your free seat here.