Finding the Best Smallcap Stocks for the Long Term

Lego is the planet's biggest toymaker by revenue.

IKEA is its biggest maker of furniture.

The Nordics are home to leading manufacturers of everything from machinery (Atlas Copco) and telecoms equipment (Nokia and Ericsson) to seatbelts (Autoliv) and lifts (KONE).

The region has also produced the world's biggest music-streaming company (Spotify) and its largest buy-now-pay-later service (Klarna). Novo Nordisk, a Danish pioneer in weight-loss drugs, is Europe's most valuable firm.

The Economist wrote this in a recent article.

Global popularity of apps like Spotify and weight loss drugs (particularly Ozempic) may have made Nordic brands household names even in India. But few know how these global entities compare to the tiny economic size of their country of origin.

The Nordic countries of Norway, Sweden, Denmark and Finland are admired for having pulled off the impossible. These tiny countries have produces businesses that dominate their respective industries at a global scale.The secret of the small companies acquiring global scale and efficiency is the limited size of the domestic markets. The small number of local consumers have forced the companies to go international and build competitiveness early on.

Consider this data, the average share of domestic revenues generated by such Nordic companies is just 2%. When you compare this to 12% domestic share for their counterparts in the rest of Europe and 46% for those in America, you get the difference.

In India there are small companies growing at massive pace thanks to the large scope of consumption growth within the borders. But the Nordic companies never had it that easy.

Now the reason I am discussing the nature of growth trajectory of the globally renowned Nordic companies is because I see a striking similarity between them and few Indian smallcaps.

There are basically four reasons that allowed the Nordic companies to do what even some of the large companies elsewhere in the world did not.

Use of Technology

Data from Eurostat show that 45% of small firms in the European Union pay for cloud-computing services.

On the other hand, the average share of companies across the Nordic region with access to cloud technology is 73%.

Thus, technology has traditionally played a key role of catalyst in the companies from the region scaling up faster.

Most smallcaps in India are using the platform ecosystem and digital modes of growth to increase their reach faster.

Focus on Research

McKinsey reckons that four-fifths of listed Nordic companies spend more on research and development than their rivals do elsewhere in the West.

R&D investment by Indian industry is still small at 0.2% of GDP.

In comparison, American corporates spend 2.7% of GDP, South Koreans 3.9% and the ones in UK 2.1%.

The good news is that macroeconomic conditions have aligned for the Indian industry to push up R&D investments.

This includes the large size of the economy, large local markets, huge startup ecosystem, focus on indigenous manufacturing and a mature R&D institutional ecosystem (support from entities like DRDO and ISRO).

Several smallcaps and startups operating in the defence, space-tech and electronics manufacturing ecosystem have taken advantage of technology tie-ups with large government R&D institutions to innovate in their product pipeline.

Government Support for innovation

Startup entrepreneurs in the Nordic regions find it less daunting to take risks knowing that, should they fail, they will have access to generous unemployment benefits and well-functioning public healthcare and education systems.

Startups in India may not have access to generous social welfare measures. But the ease of doing business and incentives like PLI have certainly come a long way in encouraging smallcaps in India to innovate.

Long Term Ownership Mindset

Business dynasties have played a prominent role in the Nordic region.

Maersk and Lego are still controlled, respectively, by the founding Moller and Kristiansen families. Though both firms are now run by professional executives, the family holding has given the management a long-term orientation for the businesses.

Similarly in India, owner operator led companies, especially smallcaps, are the preferred lot among investors. We also call them managements with 'skin in the game'.

The founders keen on long term value creation. The substantial stake of the founders in the business also gives minority shareholders the assurance of long-term earnings visibility.

Are All Smallcaps 'Bluechips in the Making'?

Well, during bull markets, investors get carried away by the sharp rise in stock prices of smallcaps.

The quick uptick in valuations give new investors the impression that almost every other smallcap is a bluechip in the making.

In reality, only a handful of smallcaps manage to live up to such expectations. So as soon as the earnings season turns the tide, the smallcaps start sliding in valuations.

It is then that investors take the 'sell now - buy later' approach to smallcaps.

Notwithstanding their fundamentals, small-cap stocks get dumped during market corrections. The assumption that they can always be bought back later at cheaper valuations could, in some cases, be a myth.

Like I explained in the case of Nordic companies, there are several smallcaps and startups in India that possess all the elements to be successful for several decades.

It is a matter of time before these entities manage to capture larger market share or disrupt markets with their innovative products and services.

Therefore, if you are wondering whether to time the markets and sell your smallcaps, make sure you evaluate them through the growth criteria of the Nordic stocks.

Don't be surprised if at least a few of the small-cap stocks that you own show some promising signs of becoming next decade's bluechip.

Warm regards,


Tanushree Banerjee
Editor, StockSelect
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)