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On This Day - 12 JUNE 2019
I Believe the Time for the Turnaround in Small-Cap Stocks Has Arrived

Richa Agarwal, Research analyst

I understand you've not had a good time with your investments in small caps recently.

This is all the more frustrating when you see the BSE Sensex making record new highs time and again.

It becomes difficult to avoid the feeling that you're perhaps the only one doing badly.

If you've been feeling this way, here's something you should know...

Stocks of a very few large companies that dominate the benchmark index, in terms of market cap and weightage, have been doing well.

However, most listed stocks haven't been doing well at all over the last 1 to 2 years.

And this is not without reason.

With the onset of the slowdown over the last few years, the earnings of many companies have taken a beating. Consequently, the return on equity, one of the important measures of the profitability of companies, has headed lower.

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Now, the earnings of large-cap companies seem to be relatively less affected.

On the other hand, their smaller-sized brethren have taken a much worse beating.

For small caps, put together, their earnings seem to have literally gone out the window.

While I see this at the individual business level I also see this at the index level. The BSE Small Cap index's earnings dipped into the negative in FY15!

And they are barely back in positive territory now.

Why do you think the BSE Small Cap index's price to earnings (PE) ratio today stands at 161 times?

With next-to-nothing earnings to show, the PE ratio has shot up to an absurdly high level.

The truth is, private investment has failed to pick up for over a half a decade now. This is the biggest reasons preventing the business cycle to turn up in any meaningful and sustainable way.

Without an up-turn in business cycle, the earnings for small companies have failed to pick up in any meaningful way.

And their stocks have suffered as a result.

This is what makes new data just out from the RBI so interesting.

As per a survey by the Reserve Bank of India (RBI), Indian manufacturers, are running at 77% of their capacity in the fourth quarter of FY19.

This is a six-year high!

Further, it doesn't seem to be a one-time spurt either. Capacity utilisation has been increasing every quarter for over a year now.

This is a significant development.

You see, fresh capacity has hardly been added for a long time now, fuelling the slowdown.

What happens when capacity utilisation rises and sustains close to full-capacity levels?

It directly converts into private investment spending.

And private investment is the single biggest missing cog in the Indian economy's wheel so far.

If the trend of the RBI data continues, it could mean a full-blown recovery in the economy.

And the number one beneficiaries would be small cap stocks.

Not only their earnings but also their stocks have been beaten down quite a bit in recent times. Both would recover sharply.

So don't lose hope dear reader.

The Sensex and large caps have had their dream run. Now it may be the turn of the undiscovered small caps to rise.

This is the time to get in!

Warm regards,

Richa Agarwal
Richa Agarwal
Editor and Research Analyst, Hidden Treasure

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