Smallcaps Will Rebound... This is What You Should Do Now

Sep 26, 2019

Girish Shetty, Research analyst

The 'Rocky' movie series is one of my all-time favourites. I've lost count of the number of times I've watched them.

The story of how a man battles against all odds to triumph in the sport of boxing sets this movie series apart.

One of my favorite lines from the movie has always stayed with me...

'It ain't how hard you hit. It's how hard you can get hit and keep moving forward'.

This quote aptly suits small-cap stocks in the Indian market.

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You see, small caps have rebounded...but they've also fallen a lot.

Since January 2018, the BSE smallcap index has taken a heavy beating. In boxing terms, it was a 'knockout'. The smallcap Index is down about 32% over the last 2 years. Many small caps have fallen 80% or more.

Most investors have moved to the 'safe haven' of large caps. Even the good-quality small-cap stocks have been punished. This is a pattern similar to the one we saw in 2013.

Corporate governance issues, weak business fundamentals of many companies were exposed. The damage has been permanent for many of them.

But the ones that survived have grown stronger. Having taken many blows, it is time for them to punch back, i.e. these small caps will rebound.

These companies kept growing and improving their business as the competition fell apart.

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How did they do this?

Well, these companies have 3 characteristics in common.

  • Clean and competent management.
  • Strong business models.
  • The ability to grow without excessive debt.

And I believe, these are the small-cap stocks which will rebound the strongest.

These companies will grow with or without government help. The tax rate cut will be an additional benefit for them.

Does this mean the small-cap rebound has already begun? No one can say that with absolute certainty.

But if you ask me... are set for a rebound?

Yes, that I am sure of.

After all, this is what we saw after 2013. The BSE Smallcap index more than doubled from January 2014 to October 2018, netting in gains of 111%.

How do you take advantage of this, dear reader? What should you do when you see signs of a revival in the smallcap space?

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First, steer clear of looking at supposedly 'cheap' stocks. The bottom fishing temptation is high during these times.

These supposedly 'cheap' stocks are cheap for a reason. Many of them face corporate governance issues or broken business models. Avoid them at all costs.

Second, look at strong businesses. Ones that rank high on fundamentals. These are businesses generating strong cash flows and growing without taking on excessive debt.

And most importantly, they should be backed by a clean and competent management.

Many such small caps are now at attractive valuations. Richa, our small cap expert, has recorded a video about one such high-quality stock.

Watch it here.

Warm regards,

Girish Shetty
Girish Shetty
Research Analyst, Hidden Treasure

PS: Richa Agarwal, our small cap expert, has found one stock with the potential to offer multibagger returns. Watch Richa's video on this one stock here.

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