Big Things Often Have Small Beginnings

Pallav Tewari
Proprietor, Jayasha Share Consultants

Small has always been beautiful. According to the Big Bang theory, the universe we are all a part of, at the beginning was very small, and since then it has been expanding, creating a beautiful world. Similarly, great companies that you see today were once very small. With time, they reached their full potential by becoming larger, in the process making investors like you rich. Great companies did not become good to great in a matter of a few months. Time, not timing, makes you rich. 

Humble beginnings are quite common. A telecom company had its roots in a garage and today has a market value of over a trillion rupees. The founder of the foremost technology services company in India took Rs 10,000 from his wife as seed capital, and today has annual revenue of Rs 90,000 crore. The massive hospital chain you see today started off with a lone center over thirty years ago. There are tons of investing stories like these that have benefitted from more incomes, more demand, and more markets as scale, competitiveness and entrepreneurship came together smoothly. Smallcaps become midcaps, which become largecaps.

The journey towards riches is often not a straight one. There are ups and downs. During phases of market correction, mid and small companies are hit harder. You can't swim in the sea and escape the high tidal waves. Mid and small companies encounter crises as well. And that is what presents an opportunity! Remember Warren Buffett's immortal worlds - '....be greedy when others are fearful'. It is easy to read a book on investing but difficult to implement when it is needed most, like in March 2020 when stock markets tanked. Return = Sales Price (SP) - Cost Price (CP). In a crisis situation, CP comes down which cements the probability of good returns going forward.

The equities market in India has a favorable tailwind. This factor is lower interest rates. Historically, lower interest rates are always a very big trigger for a rally in equity markets. High interest rates bump up the cost of business, especially mid and small ones. Lower rates, thus, are a big boost for business. But it's easy to lose sight of these fundamental drivers, when the news and noise is heavily about only coronavirus/Covid-19, economic slowdown, unemployment etc. But once the pandemic is over, survivors will be the outperformers.

After the rollicking rally since markets hit lows in March, concerns have been abound about whether equities have run up too soon and too fast. Unfortunately, a lot of attention is given to one single ratio - Price to Earnings (PE), which isn't always an efficient method to measure the value of a company. Since PE is actually a derivative of cash flow-based valuation, only larger companies appear good. As a result, Nifty 50 has a PE of 32.7 times but Nifty Smallcap 250 has a PE of 57.3 times. This skewed way of looking leaves out most small sized firms, which are potentially big wealth generators. Objective analysis is based on metrics like Price to Book (P/B), Profit to GDP etc. Nifty 50 trades at over 3 times its book value, but Nifty Smallcap 250 trades at 2.2 times.

Valuation trends are important too. The Small Cap to Total Market Cap ratio is at one of the lowest levels today. Current free-float market cap % of Nifty Smallcap 250 to Nifty 50 is down by almost 30% from the January 2018 peak. What's more, the ratio at 8.84 is also below the nearly ten-year long term average of 9.3.This shows the risk reward is turning favorable for smallcaps. In pockets, largecaps are good but the whole largecap index is not cheap. To create sustainable wealth, it is important to buy cheap. Ugly ducklings nurtured well will one day become regal swans.

The April to September rally in Indian stocks was no random outcome. For every 50-60% gainer in largecap index stocks in the last one year period, there is a 200% to 1000% winner in smallcaps too. Such scenarios have played out in 2008 as well, when the Global Financial Crisis was at its peak. Markets crack and then rise back up.

Bull markets are born on pessimism, grow on skepticism, mature on optimism & die on euphoria. Currently the Indian market is at an early stage in this cycle and we are growing on skepticism. This presents an opportunity. Big was great, but now the time has come when small is beautiful. Midcaps and Smallcaps are a good buy at this point in time.

The writer is a Proprietor, Jayasha Share Consultants
 Email id : pallav.tewari@gmail.com
Website : www.jayashawealth.com