Thriving 400 Small Cap In 2016

Investors worldwide have always found investing in small cap space irresistible.The temptation of investing in micro cap and small cap is such that any seasoned investor having spent considerable amount of time in equity markets may have at least once in his or her investing career dabbled with a small cap stock thinking that it will some day become a multibagger.

Small cap stocks are not always the big fishes that everyone is aware of. But they are attractive from investors’ point of view for its ability to offer great returns in the long run and not comparable to any other asset class – period.

‘Great growth potential,’ is the single most important aspect of small cap investing and investors often are clingy about such prospects of multiplying wealth faster.  Indeed an astronomical amount of money can be made by investing in right small cap stocks. But an eternal question remains unanswered what is a right time and stage for a small cap stock to invest in and how to go about small cap investment because there are multiple anecdotes which suggest many individual investors have seen their capital getting completely wiped out for aggressive capital allocation in small cap stocks.

Inspite of all of the inherent risk that are typically attached with small cap investing , the reason why these micro cap and small capitalisation stocks are always in fashion is their ability to grow at a faster rate owning to their lower market capitalisation. On a relative basis, it looks highly unlikely or almost impossible for any large company to grow as fast as the small cap because the large cap companies would eventually become unsustainably large. With small cap companies it can double its market cap manifold once it gets its act together on startegy front.

The logic behind the requirement of a larger portoflio (number of stocks) to be diversified, when it comes to small cap companies, is that small cap stocks tend to be concentrated in a few sectors. Taking a long term view will be an essential element in small cap investing and as the small cap universe may not always be covered by analysts in general, the responsibility for due deligence and information gathering will fall upon the individual investor.
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Hitesh Agarwal, EVP & Head – Retail Research, Religare Securities

Are investors focusing to invest in small cap stocks for short term or medium term?

Small-cap stocks have always been on investors’ radar with the primary assumption of making a quick return on investment. However, this trend is shifting, though gradually, but surely, towards investing in small-caps for a period beyond the near-term. This gradual shift in trend could be attributed to various factors including greater awareness about advantages of holding a small-cap stock for some period of time, relatively greater availability of information regarding small-cap companies adding to investor confidence and understanding the risks associated with short-term trading.

Are investors, in your view aware of the risks involved when they invest in small cap stocks? Are there any additional risk attached with small cap investing? 

The informed investors are definitely aware of the risks involved in investing in small-cap stocks. However, unfortunately, the percentage of this category of investors is still not large. Undoubtedly, while small-cap stocks with strong balance sheet and earnings potential can multiply investors’ wealth over a period of time, there is also a relatively higher level of risk attached when compared to large-cap companies. The biggest risk is the volatility in the stock price of small-cap companies. Especially, during market corrections or panic situations, small-caps, which would have run up sharply, are the most vulnerable to correct.

If one has to construct a small cap portfolio, what pointers would you recommend for investors to keep in mind? 

 An investor looking at building a small-cap portfolio should more-or-less ensure the following before investing: i) clean management track record with good transparency, ii) the industry in which the company operates offers high growth potential, iii) the company should be capable enough to capitalise on the opportunities and deliver faster growth compared to peers. This can be judged from its past financial track record, market position and brand strength, range and extent of differentiation in product offerings and client base, iv) sound balance sheet with low leverage, high return ratios and consistency in generating healthy cash flows.

Are you seeing increasing interest in small cap stocks from institutional investors? 

Yes, especially over the last 2 to 3 years, institutional investors have been showing interest in investing in small-cap companies, since these stocks have the ability to generate higher returns compared to large caps, and consequently the necessary alpha for the fund managers’ portfolios. A capable small-cap company has the potential to achieve faster growth because of low base, compared to its large-cap peer, where the potential for aggressive expansion and growth is low due to high base. Also, despite their high growth potential, many small-caps are trading at relatively affordable valuations, as they are not well discovered, thus opening up greater scope for higher returns.

In your experience, do retail investors confuse between a small cap stock and a penny stock? How will you differentiate between a penny stock and a small cap stock? 

Many retail investors do get confused between penny and small-cap stocks. Penny stocks are generally very low priced (mostly low single-digit), have very small market capitalisation, don’t have good fundamentals with little or no transparency and are speculative in nature (news based). Further, their frequency of financial statements could be inconsistent or non-existent. On the other hand, a capable small-cap stock might be priced low or have low market capitalisation, but does have a noteworthy fundamental / financial track record and is generally traded on exchanges, even though the traded volumes may be low.

Conclusion :-

Investing in small caps and constructing a strictly diversified portfolio of high quality micro cap and small cap stocks without ignoring the valuations can be a perfectly sustainable market beating strategy. There is no doubt that small cap investing can beat large cap investing on risk adjusted parameters over long term as is reflected by historical perfomance; trick lies in the execution of the strategy and discipline. Individual investors lacking either the inclination, motivation or skills to  identify and pick quality micro cap and small cap may look at investing in mutual funds that are primarily focused on micro cap and or small caps.There will often be a thin margin of error while constructing a small cap portfolio and hence it is of paramount importance that the investor concentrates 100 per cent on basics of portfolio diversification and construction as the ultimate objective for any investor should be to optimise the risk adjusted returns and not merely chase growth at an irrational price which can not only make the whole investing game unprofitable but also a painful waste of time.Happy and safe investing!

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Pankaj Pandey Head of Retail Research, ICICI Securities

S&P BSE Small cap index has outperformed the Sensex over one year period. What is your view on the small cap investing at this juncture? Do you see the small cap index outperforming the broader markets?

S&P BSE Small Cap Index has outperformed Sensex over the last one year by delivering ~18% return (~2x of Sensex returns). In the current market scenario wherein there are growth challenges for the large cap companies amidst a lot of uncertainties and disruptions both domestically and globally, we did see a lot of small cap companies having the potential and management bandwidth to make it big in their respective domain. We believe a small portion of one’s portfolio could be deployed in the small cap domain as it has the potential to generate above market returns. We have a product line named “Nano Nivesh” wherein we recommend small cap stocks (market cap less than Rs 1000 crore) companies with good and scalable business models, dependable management and sound financials.

While it will be difficult to fathom a guess on small cap index return, we do continue to advise selective small cap stock picks. We recommend investors to focus more on domestic economy linked stocks rather than exports given the turbulence in the foreign exchange market. Furthermore, we also continue to advise that small cap investing is a highly risky composition and exposure to small cap space warrants a higher risk appetite.

What are the key risks an investor should understand before taking exposure to small cap stocks?

Apart from the usual risks associated with investing; involving demand scenario, profitability, leverage, working capital control, cash flows, return ratios, valuations etc. key risks associated specific with small cap investing are:

1. Liquidity- Most of the small cap companies stocks have low liquidity. The low liquidity exposes them to the risk of manipulation by market participants. Another issue emanating from lower liquidity is inefficient price discovery of the small cap stocks.

2. Disclosures- A lot of small cap companies do not adhere to high standards of corporate governance and hence there are limited disclosures to stock exchanges regarding their key events.

3. Management access- It is difficult to get through the management of small cap companies since lot of them are not professionally managed and hence as an investor it would be difficult to know management’s vision on company’s business and its future plan of action. Consequently, these stocks are not widely researched and hence there are hardly any secondary data points available.

How much allocation should be given to small cap stocks in a portfolio given the various risk profile of investors’ viz., aggressive, moderate and conservative?

We believe a small portion of one’s portfolio could be deployed in the small cap companies with good and scalable business models, dependable management and sound financials and thus has the potential to generate above market returns. The percentage allocation, however, depends on one’s risks appetite. While for an aggressive investor, allocation to small cap could be as much as ~10-15% of the portfolio, exposure to small caps stocks for a conservative investor should be minimal.

Are you seeing FIIs interest in small cap stocks or is it still predominantly large cap stocks that attracts foreign portfolio money?

Small cap domain has not really seen any FII/foreign portfolio money and it is predominately limited to the large cap domain and mid cap space to some extent. Few reasons for absence of FII participation in small caps could be liquidity, lack of disclosures and minimum market capitalisation mandate of the FIIs.

Nitasha Shankar - Sr. Vice President and Head of Research, YES Securities.

Do you think small cap stocks as a group can outperform broader markets in near to medium term?

Ans.: Small cap stocks have already outperformed broader markets for the past year. The Nifty Freefloat Smallcap Index has been up ~24% in the one year ended  August 23 while Nifty was up ~10% during the same period. At the same time, valuations of most small cap stocks have peaked as earnings have not kept pace with the run up in the stock prices. As a result, we believe that going forward movement/performance in the small caps space would be stock specific; specific to those stocks that are able to grow their earnings at a robust pace given their better quality of business models and/or growth prospects.  

Q2. How has been the earnings for the small cap stocks for the Q1 FY17?

Ans.: It has been a mixed bag. While most companies have reported better growth in earnings, however they have lagged behind in terms of top line growth which suggests that meaningful in recovery in demand is still a while off.

Q3. Perception is that small cap stocks are risky investments. Do you agree?

Ans.: Small cap stocks tend to outperform broader markets during growth phases and tend to sharply under-perform when the tide turns. Due to this high beta nature, they are relatively more risky as compared to larger cap stocks. Therefore stock picking becomes even more important in case of small cap stocks.

Q4. What is appropriate allocation to small cap stocks in a model portfolio in your view keeping in mind risk profile of investors?

Ans.: That would depend on the risk profile of the investor and the understanding with their investment advisors.

Q5. Are you seeing incremental institutional money (FPI & DII) coming into small cap stocks?

Ans.: Institutional activity in small cap stocks has been very selective. In certain stocks that have shown resilience even during tough times due to their niche/attractive business models and/or those with robust growth prospects have attracted institutional funds in recent times.

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Amarjeet Maurya, Sr Research Analyst (Mid-small cap) , Angel Broking

Q1. In your view is valuation stretched in the small cap space at the current juncture?

Reply :- If you are comparing with large caps and I am not talking of the whole small cap index, I can say that lot of small cap stocks have rallied a lot and many of the small cap stocks have outperformed the broader markets and large cap stocks. Individual stocks in the small cap space have generated lot of returns and definitely the valuations are stretched at the current point of time. Most of the small cap stocks are overvalued and stretched in valuations in our view. 

But , because the small cap and mid cap stocks are overvalued at current juncture, it does not mean that investors have stopped investing money in these stocks and are shifting their portfolio to large cap stocks. There are certain themes playing out in favour of small and mid cap stocks. 

Q2. Is incremental money getting invested in small cap & mid cap space or is it skewed towards large cap 

Reply:- Like I said people are still investing in small and mid cap stocks as there are essentially three themes supporting the smaller size companies :-
Government Spending
Consumption story
Infra Spending 

These three themes can be focused on while investing in small cap space. For the last two years we have had below average rains and the rural theme could not be invested in. Now with monsoon better than previous 2 years, focus can be shifted back on the rural consumption story and one should invest in those small and mid cap stocks which have rural exposure. 

Focus on quality stocks related to the consumption story and consumer durable story that may benefit from the 7^th pay commission can be considered for investing opportunities. Bottom line can grow at a healthy rate for these stocks. 

Q3. What in your view are the risks of investing in small cap stocks?

Reply :- As of now small cap stocks are very small and they are dependent on larger companies and other industries for business. To cite an example, if a small cap auto ancillary company is dependant upon the OEM (Two wheelers/three wheelers/Four wheelers) and if the OEM is slowing down then these small companies suffer as well. I can say that if you invest in quality small cap stocks most of the risks associated with small cap investing can be done away with. Overall economic slowdown is another factor that needs to be taken care of before investing in small cap stocks as well. 

If one sticks to the themes as discussed earlier, I see lesser risks i.e government spending , 7^th pay commission , rural consumption story and infrastructure spending. Chances are that the investors will be rewarded by investing in these theme related stocks. The impact of the 7^th pay commission will be seen soon. There is less risk while investing in the domestic story. Plus the small cap stocks are high beta risk. One can minimise the risk of small cap investing by sticking to the domestic story at the current juncture, which will not be impacted by global market risks.

Q4. Do you think small caps will outperform large caps in near to medium term?

Reply :-As of now, the quality stocks falling in the space that we discussed with reference to three themes in my previous answer, will report QoQ better profits & growth and hence will definitely outperform broader markets in the long run. I will screen for stocks in rural based story and agri based story where the future looks bright for the company. While looking for lower valuation stocks, focus needs to be on those stocks which have not rallied much.
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Partha De Sarkar, Global CEO, Hinduja Global Solutions (HGS)

Q1. Who are your typical clients? What value added service are you able to provide to your clients which helps in retention of clients?
As a leading BPM player, HGS supports 190 clients with core BPM services and over 600 HRO and F&A clients currently. These clients are typically Fortune 500 companies originating from various industries including healthcare insurance, BFSI, retail & e-Commerce, consumer products, telecom & technology, public sector etc.

The kind of relationship we have with them can be gauged by a simple stat: 72 percent of HGS’ clients have been working with us for over 10 years globally. HGS believes in building long-lasting partnerships where our associates act as the face of some of the world’s leading brands or as extended teams at the back-end, depending on the engagement. This means that we are able to leverage our connects with their end-customers to proactively suggest solutions that can directly impact revenue generation or create cost savings for clients.

To give an example: HGS has worked with a government agency in Europe to create a digitally enabled customer experience solution for the millions of foreign nationals who seek information from its website and apply for visas. The platform supports applicants from 222 countries in 22 languages through email, web chat or voice, and has seen over 125,000 visitors accessing the self-service portal even as a total of £1 million in cost savings was passed directly to the applicants as a result.

We have also partnered with a luxury car brand, looking to expand in Europe, in building a state-of-the-art customer care centre by leveraging our DigiCX platform to support a unified engagement via voice, email, chat and high-impact video chat. We have seen the lead and test drive processing improve from up to 10 days to within 2 hours and increased uptakes from 30 percent to 65 percent. The outstanding support helped the client to be listed in the Top 50 Companies for Customer Service Club in the UK for 2015.

In another instance, a healthcare insurance client reached out to HGS to help improve workers’ compensation experiences in the area of medical bill reviews. From a 12-member pilot, this program has now grown to over 250 FTEs supporting 13 processes in front and back office. HGS has helped save $41/ bill on average and $4 million in just nine months.

Q2. What can you tell us about your sales and marketing strategy to grow and how is it helping HGS improve its revenue and profits?

A couple of years ago, we decided that we would set up a dedicated sales and marketing team called GGSM to help drive all market and client-facing activities for us globally. This team works with the business units to identify opportunities with both existing and new clients, and build the right solution packages for engagements. In the last few months, HGS has launched innovative solutions such as Health+CARE, HGS RPA (Robotics Automation Processing) and DigiCX suite of services, which are seeing significant traction in the market. These are creating newer streams of revenue generation for us.

Our sales pipeline has grown consistently across geographies even as we added newer sub-verticals like e-commerce and fitness. This has led to more wins, especially with new logos. In FY 2016, we signed 20 new clients, including three major public sector clients in the UK and Canada; and in first quarter of this year, we added five new clients with an ACV of about $4.5 million.

Q3. How is digitisation affecting your business and is your company able to tap on the digitisation transformation happening in India?

Digitisation is a global trend impacting businesses and consumers across geographies and industries every day. HGS is seeing lot of demand for digital-based services from clients, including in India, as companies begin to focus more on what the consumer wants and how.

Robotic Process Automation (RPA) is a new area of focus for us. An early adopter in this segment, HGS has developed platform-agnostic solutions that can ensure value maximisation for clients. We are already working with five clients in healthcare, BFS and insurance verticals through gain-share commercial models. We believe that this is a big opportunity for HGS, as evinced by analysts like Everest Group stating that RPA adoption in BPM is growing at a CAGR of over 100 percent and is likely to impact 30-40 percent of BPM spend in the long run.

A few months ago, we launched HGS DigiCX, a suite of digital customer experience services that focuses on transforming traditional call center customer experiences. Under this umbrella, we have introduced innovative offerings - DigiWEB, DigiCHAT, DigiTEXT, DigiSocial and DigiINSIGHT. We expect the DigiCX suite of services to help us capture new revenue streams in our clients’ customer experience journey, by driving improved loyalty and net promoter scores. To share an example, a large media company in India has engaged HGS to support their customer service communications across multi-channels, including social media, email and voice services from Mumbai. In FY 2016, HGS signed 21 digital engagements and six in Q1 of current fiscal and we are confident this number will grow faster.

Q4. Across geographies, how is the growth trend for your company?

Partha: HGS posted a strong performance in Q1 FY 2017, growing 23.1 percent y-o-y in revenue and 212.4 percent y-o-y in PAT.

Beyond these immediate financials, the last few quarters have seen significant growth in new business, with both existing and new clients contributing to the growth. This has been across our geographies and industry verticals. In fact, our healthcare vertical recorded a growth of 30.4 percent in Q1, and now contributes 43 percent of HGS’ total revenue.

With clients viewing India, Philippines and Jamaica as popular destinations, we are driving a change in onshore/ offshore and nearshore mix, that is helping margin growth. The company is also focused on expanding our delivery footprint, we have added three new centres so far this fiscal and will continue to add more based on demand.

Q5. Going forward, what is your company's expansion plan and at what rate you see your company growing in coming years?

HGS continues to grow its delivery footprint to cater to client demand, both by expanding in existing centres and setting up new ones. This expansion also includes adding headcount-we added over 11,000 people and 1,000 people in FY 2016 and Q1 of current fiscal, respectively.

We don’t provide guidance to revenue growth but we have been growing consistently at a CAGR of over 20 percent in the last few years.
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FIEM Industries

FIEM Industries (FIEM) is one of the leading manufacturers of automotive lighting and signalling equipments and rear view mirrors in India. FIEM is among few first companies in India introducing LED lights in two wheelers. FIEM has diversified its product portfolio by entering into LED luminaires for indoor and outdoor applications and Integrated Passenger Information System for railways and bus fleets.

FIEM has a diversified product portfolio ranging from head lamps, tail lamps, signalling lamps, roof lamps, rear view mirrors, wheel covers, warning triangles, complete rear fender assembly, frame assembly, mudguards, various automobile sheet metal and plastic parts.

The company is fully equipped with world class R&D and testing facility and has developed in-house capabilities in LED technology and manufacturing. 

The company generates 94.50 per cent of its revenues from two wheeler segment whereas 5.50 per cent of the revenues for the company is generated from the four wheeler segment.

Total Income for FIEM industries has grown from Rs 428 crore in FY11 to Rs 989 crore in FY16 at 5 year CAGR of 18.24 per cent. The company’s EBITDA has grown from Rs 38 crore in FY11 to Rs 128 crore in FY16 at a 5 year CAGR of 27.60 per cent. Its net profit has grown from Rs 11 crore in FY11 to Rs 57 crore in FY16 at a 5 year CAGR of 38.86 per cent.

Pokarna

Pokarna is India's leading exporter of granite and largest exporter of quartz surfaces. The company offers vast range of granite quarried from over 10 mines and finished at two factories in Telangana. Pokarna possess the best of manufacturing technologies from processing granite and manufacturing engineered surfaces. Pokarna exports its products to over 50 countries. The company also manufactures and retails apparel under the brand ‘STANZA.’

The company intends to strengthen its Quantra brand primarily through continued investment in R&D, marketing activities and establishments of long term relationships with distribution players in the key markets and continue to strengthen the relationship with private label manufacturers.

The company is relatively large and organised Indian company to have bouquet of granite and quartz offering and is well positioned to become an important player in the international markets.

The EBIDTA margins for FY15 came at around 26 per cent which jumped to about 33.7 per cent in FY16.Revenue for the quarter stood at Rs 90 crore against the revenue of Rs 96 crore in the quarter of previous year reflecting a de growth of 6 per cent. Primary reason for the revenue contraction being temporary reduction of production in some quarries owing to pre-exploration and development activities combined with weaker currency advantage of competing market players. PAT stood at Rs 16 crore as against Rs 12 crore, higher by 32 per cent.

HGS

HGS with operations in 11 countries, continues to invest in growth as the company approaches Rs 3000 mark in annual revenues. HGS digital transformational offerings disrupt traditional outsourcing services with the integration of online, social media and self service solutions along with live person client interactions and transactions. The company is recognised as a global market leader in servicing the telecom, media and healthcare verticals as well as in the digital transformation space.

Healthcare vertical has been a stand-out performer and reflected a 40 per cent growth in rupee terms year on year. HGS is building high-value domain expertise by recruiting subject matter experts like doctors and registered nurses in addition to scaling up-skilling regular associates.

New acquisitions will help HGS add new clients and augment company's service capabilities and marquee clients in the telecom and banking & financial services (BFS) space. HGS reported net sales of Rs 28076 million, a growth of 12.1 per cent over 1 year. PAT for year stood at Rs 1650 million a decline by 2.7 per cent accounting for higher depreciation charges on account of implementation of the Companies Act 2013. HGS Reported EBITDA was Rs 3172 million with a margin of 11.3 per cent. The margins were impacted by various factors including ramp-up costs and currency volatility.

Surya Roshni

Surya Roshni is an interesting play related to development in infrastructure space in India. The company has Asia's largest ribbon glass plant in Gwalior, MP.  Surya Roshni is the only lighting company with 100 per cent backward integration and it manufactures all its components.

Surya Roshni is the Largest G.I & Hollow Section Pipes Manufacturer and the company is the second largest seller of GLS and FTL in India. The products of the company are popular as the said company's products are energy efficient and have more life. With presence in more than 44 different countries, Surya Roshni offers a vast range of product line - up including Tube Lights, GLS, CFL Lamps, wide range of LED's, HPSV / Metal Halide Lamps, Street Lighting , High Bay Lighting, flooding lighting, landscape lighting and High Mast and thereby participate in the growing infrastructure sector. The company provides a wide categories of designer and colourful range of ceiling, table, pedestal & wall mounting fans along with wide range domestic exhaust fans.

The company can expect to see growth with several new launches in pipeline. The contemporary range of electrical home appliances to be launched in the first phase and the plans to launch kitchen appliances in the next phase can trigger growth for the company.

On financial front, Surya Roshni’s revenue increased by 17.13 per cent to Rs 3544 crore in FY16 as compared to previous financial year. The company’s operating profit too rose by 34.38 per cent to Rs 311 crore in FY16 on yearly basis. Its net profit also increased by 40.43 per cent to Rs73.46 crore in FY16 as compared to previous fiscal year.

Rama Steel Tubes

Rama Steel Tubes has diversified clientele with over 200 dealer distributors & association with Reliance, DLF, GAIL, Delhi Metro. The company has wide product suite across key sectors in automobiles, infrastructure, real estate, furniture. It has robust exports to over 16 countries.

On financial front, Rama Steel Tubes’ revenue increased by 25.55 per cent to Rs 65.43 crore in Q1FY17 as compared to same period in previous financial year. The company’s operating profit boosted more than two times to 5.47 crore in Q1FY17 on yearly basis. Its net profit also increased by five times to Rs 2.61 crore in Q1FY17 as compared to same period in previous fiscal year.

On yearly front, Rama Steel Tubes top line increased by 25.73 per cent to Rs 242 crore in FY16. The company’s operating profit boosted more than two times to Rs 17.66 crore in FY16 as compared to previous fiscal year. It posted net profit of Rs 6.02 crore in FY16 against net profit of Rs 69 lakh in FY15.

Rama Steel Tubes commenced its second production line in Khopoli, adding an additional of 36,000 MT to the existing capacity. The company’s Khopoli plant is very strategically located, servicing the key high growing markets of Maharashtra, South Gujarat, North Karnataka and Madhya Pradesh. These units offer an increased range of diverse and value added products and enable to bring down the logistics cost, positively impacting realizations and profitability.