400 Small-Caps

Investing in small-cap stocks is in vogue globally as small-cap stocks are considered long-term investors' best friends. Yogesh Supekar and Tanay Loya hunt for the best small-cap stocks available for investment at the current juncture and recommend staying invested in them for the long term.

Sensex is up by nearly 14 per cent over the past one year and is trading at 18.6 times its projected earnings. Nifty has moved from 20.95 P/E multiple to 25.89 over the past three years. With corporate earnings yet to see signs of revival, majority of analysts believe valuations are on the higher side. While valuation concerns and global geopolitical tensions are affecting the market moods, small-cap stocks continue to impress investors with their performance.

Small-cap investing is again the talk of the town as the category continues to outperform its peers on the Indian bourses. Well, we observe that the trend is global and not restricted to India. The small-cap equity as an asset class has outshined all the other asset classes on multiple year basis.

Popularity of mutual fund investing has a lot to do with the liquidity in the markets today. Lack of investment choices are driving many investors towards mutual funds in India. Balanced funds, small-cap funds and mid-cap funds are amongst the most popular categories of mutual funds with investors in recent times.

The rebalancing of asset allocation of Indian investors is in progress and mutual funds are its biggest beneficiaries. With mutual funds being one of the biggest beneficiaries, small-cap stocks become a natural beneficiary indirectly as the fund managers deploy the new funds in high growth small-cap and mid-cap stocks. We can say that retail investors' continuous buying of equity via mutual funds has pushed the equity valuations higher.

The million dollar question is: Will the small-cap outperformance continue in the coming years and whether investors should allocate more of their funds to the category. The answer definitely is not as easy at it may seem, because historically, we have seen that when markets are in consolidation phase, the small-caps have a tendency to crack more than their large-cap peers. Having said that, any correction due to the global geopolitical factors or high valuations should present investors an opportunity to enter the markets.

Owing to some extraordinary performance by the small-cap category over the last 5 years, retail investors are increasingly showing interest in parking their funds in the small-cap stocks. While there may be little doubt that small-caps can be more volatile than their large-cap peers, retail investors have a preference for the category looking at the return potential. Says Suraj Agarwal, who is an HNI and has been investing in stock market for more than 16 years now, "Small-caps, if chosen carefully, give excellent returns across all market conditions." 

Haresh Mehta
Chief Institutional Trader,
First Global

"Traditionally, institutional investors worldwide have tended to focus on large-cap stocks for the obvious reason that they find them less risky, have better corporate governance, better liquidity and greater investment capacity as compared to small-cap stocks. However, recently, we are seeing a big paradigm shift happening and now small-caps are becoming an important part of institutional portfolio across the globe. More importantly, the revenues of small-caps are exposed to domestic sales, hence are less affected by global worries"

Ritesh Ashar
Chief Strategy Officer,
KIFS Trade Capital

"Investors are betting on small caps as they are seen as multi-baggers. They are also considered as the riskiest segment in the capital market"

WHY SMALL-CAP STOCKS CAN BEAT LARGE-CAP STOCKS 

Even as the future of a small company may seem unpredictable, they are quick to rebound faster in the developing economies as compared to the larger companies. The growth momentum of these companies do not directly rely upon the macro factors of the economy such as interest rates, unlike larger companies.

The small companies typically rely on investors rather than borrowing funds to raise capital, unlike large companies whose vast needs of funds are mostly met with high amount of borrowing. This makes the small-cap companies immune to any changes in interest rates, besides keeping the likely burden of surmounting interest cost at bay.

Small-cap companies (and most growth-oriented stocks across all market caps) typically raise most of their capital from investors (by selling shares of stock), as opposed to borrowing money (by issuing bonds) like larger companies. Therefore, higher interest rates have less negative impact on the ability of small companies to grow, because they do not rely heavily on loans (bonds) to expand operations and fund projects.

Small companies are able to take more rapid decisions about products, services and operations with lower instances of red-tapism and bureaucratic impediments, unlike large enterprises.

Thus, small-cap stocks make for an investment haven, especially at a time when the economy is recovering from a slump or a recession. In an environment conducive to growth, the small-cap stocks respond more quickly and potentially grow at a faster pace as compared to the large-cap stocks who have much higher stakes.

ECONOMY OUTLOOK :- 

Stock market fortunes are linearly related to the economic growth of the country in the long run. Recent economic data suggest there is a visible slowdown in the Indian GDP growth. On the negative side, the GDP growth has slowed down and the Index of Industrial Production (IIP) contracted 0.1 per cent YoY in June 2017, as against 8 per cent growth in June 2016. India's gross domestic product rose 5.7 per cent in April-June from a year earlier, missing the economists' estimates. The gap between the index P/E multiple growth and GDP growth is also at multiple-year highs.

On the positive side, direct tax collections jumped 19 per cent in the four months of the current fiscal, as demonetisation of higher denomination currency bought in more number of individuals into the tax net.

Says Sanjeev Prasad, Co — Head and Managing Director, Kotak Institutional Equities , "We believe market participants may be ignoring the structural challenges to India's GDP growth by overly focusing on the cyclical factors of demonetisation and GST. In our view, weak investment demand (30% of GDP) is a far bigger ‘structural' challenge for the economy. We are not sure how this will change in the short term. We note that continued weak investment will affect consumption eventually, high government expenditure notwithstanding."

Vikas Agarwal
Co-founder & CFA ,
CAGR Funds

"A conservative investor should try to restrict the exposure to small-cap stocks to 15-20 per cent of his portfolio. Also, for aggressive investors, it should not exceed 40-50 per cent of their portfolio. The time duration is also an important consideration for smallcap stock investment and a minimum horizon of 7 years is suggested for such investments. "

Anita Gandhi
Whole Time Director,
Arihant Capital Markets

"Small cap companies have potential to grow faster than the average growth of large companies as their base is small. As they enjoy higher growth, they generally enjoy higher valuations and, therefore, having possibility of offering multiple returns. In early 90s Hero Motorcorp (Hero Honda then) was also smallcap company and over a period 2/3 decades it has become large cap company and has rewarded investors multifold. There are many such small cap companies that have emerged as large caps and have given consistent returns to the shareholders. However, retail investor should keep in mind that they should invest only in those small-cap companies that have good management and are having good corporate governance policy."

CORPORATE VOICE

"Being a small-cap company, we may have to work hard and spend little more time to raise funds from the market. However, considering the growth in our revenues, profitability, service offerings and the quality of acquisitions, which may enable us to raise funds at better valuation. We are almost a debt-free company, as our short term and long term loan on the books is very marginal at Rs.7.50 crore in the last financial year. The company has been depending on debt for its expansion and current business growth. Internal accruals are sufficient to take care of our expansion plans. We are open for mergers and acquisitions in the near future. To meet this requirement, we keep options open for raising funds in the near future." 

L. N. Ramakrishna Managing Director, Bodhtree Consulting Limited

Small Cap Stock Performance

Out of total 771 small-cap stocks, almost 66 % stocks have delivered positive returns over a one year period. At least 8.62 per cent of the 771 stocks, i.e 67 companies have more than doubled in over one year.

More than 24 per cent of the small-cap stocks, i.e 187 companies have delivered returns between 50 to 100 per cent over the last one year. Almost 323 companies or more than 41 per cent of the small-cap companies generated returns between 25 per cent and 50 per cent in the period under consideration. 

Past Small-Cap Recommendation Performance

In issue no 20, volume 31 dated Sept 5-18 , 2016 we had recommended five small-cap stocks in our cover story titled , "Small, but significant, when it comes to owning them".We had recommended FIEM Industries, Pokarna, Surya Roshni, Rama Steel Tubes and Hinduja Global Solutions. Out of these five recommended stocks, Pokarna, Surya Roshni and Rama Steel Tubes have delivered positive returns, whereas FIEM Industries and Hinduja Global Solutions witnessed downward movement. Pokarna showed a nominal annualized return of 50.96 per cent, whereas Surya Roshni and Rama Steel Tubes have shown stupendous annualized growth of 288 and 421.45 per cent, respectively. On the other hand, FIEM Industries and Hinduja Global Solutions gave annualized returns of -17.10 and -15.72 per cent, respectively.

CONCLUSION: -

A good stock is a good stock to buy, notwithstanding its market capitalisation. Investors should not get carried away by the recent run in small-cap stocks. Small-cap stocks seem to be extremely popular with the investing community lately due to their recent performance. Also, due to tapering of growth in large-caps, investors find relative higher growth in small-caps attractive. It is widely perceived that small-cap investing is risky. The fear of small-caps being extremely volatile may be overblown, as our research suggests that small-caps in the long run are not as volatile as they are perceived to be. With the global fund managers looking positively at emerging market small-cap stocks as an asset class within equity, chances are that there will be no dearth of liquidity in small-cap stocks.

With lot of investors' attention, both retail and institutional, on small-cap stocks, one needs to only avoid highly leveraged stocks with poor earnings outlook. In the current market scenario, with slowdown in GDP and expensive valuations, the expectation on small-cap stock returns need to be realistic. We believe that small-cap stocks as a category may still outperform their peers in large-cap space. However, the returns in the coming years may not be as high as we have seen in the previous three to five years.

Nitasha Shankar
Sr. Vice President and Head of Research
YES Securities (I) Ltd.

"Taking a stock-specific call is the way to go "

Small-cap stocks continue to outperform the major benchmark indices. How long do you think this outperformance will continue? 

Historically, in the various time periods leading up to market peaks — 3, 6 and 12 months — the small-cap stocks have most of the time outperformed the large cap peers and under-performances have been marginal. During periods where small-caps have outperformed their larger counterparts (represented by a wide margin), the decline thereafter has been just as sharp.

With the outperformance occurring this time around as well, that too at a quick pace, it would be prudent to book some profits. Having said that, one key factor that is different this time around is the overall improvement in the balance sheets of the small-cap companies, which has led to a broad-based re-rating within stocks that form part of the index that represents small-caps. This is one factor that makes a historical comparison not so easy, and thus, taking a stock-specific call is the way to go about things.

What are the common misconceptions surrounding small-caps? 

Investors often confuse ‘cheap' with the absolute price of a stock. For example: a company, whose stock trades at Rs.5 would often be considered as a more attractive investment than one whose stock is trading at Rs.1,000. One cannot be any more wrong. Let's assume two companies have the same annual profit figure of Rs.1 billion. One company has 1 million of shares outstanding, while the other has 1 billion shares outstanding. The EPS thus is INR 1,000 in case of the former and INR 1 for the latter. If we assign both the companies the same earnings multiple (assuming all other things being equal) of 14x, then their shares would trade at INR 14,000 and INR 14 respectively. One may be easily fooled into thinking that a stock trading at Rs.14 can rise to Rs.18 much easily than an investment of INR 14,000 rising to INR 18,000.

Prominent examples of how large value stocks have outperformed include MRF and Eicher Motors. Investors should instead gauge attractiveness in the form of the various valuation methods — with the key ones being, dividend yield, price-to-equity ratio, free cash yield, among others.

Another common misconception is that small cap stocks are more risky because of their size and sharp movement in stock prices. A company earning very strong and stable RoCEs and margins with good operating cash flows and steady growth, but having a market cap of INR 300 cr could be a much more attractive investment (i.e. when invested at a fair price) as compared to a largesized behemoth with not so great fundamentals (having cyclical business and commodity-product business traits) trading at similar valuations. Also, price volatility in stocks can in fact be used to one's advantage, rather than being considered as a risk.

At this moment, would you prefer investing in small-caps instead of mid-cap and large-cap stocks? 

For an individual to have a healthy investment track record, it is equally important to cap the decline as it is important to get upside calls right. Given the run up in stocks, valuations have become a bit stretched when gauged from a broad perspective. To justify the same, the earnings performance will have to match up.

At the end of the day, valuations are determined by factors such as the quality of earnings, the predictability of those earnings and the staying power of companies. Instead of classifying stocks as mid, small or large cap in nature, one would do better to look at the qualitative factors like financial ratios, balance sheet strength, stance in industry, the changing industry dynamics, competitive pressures, amongst others. An investment in a company with good economics and growth prospects is bound to fare well over the long run, even if not purchased at the cheapest of valuations.

Cholamandalam Finance Journey From Small-Cap To Large-Cap

"Creating value for all stakeholders is the fulcrum of our business "

N Srinivasan ,
Executive Vice Chairman & Managing Director
Cholamandalam Finance

How has been your journey from being a relative small player in equipment finance player in 1978 to a large diversified financial service provider currently? 

It has been an amazing journey so far and we have been able to touch so many people's life. In our journey covering four decades, we have grown our clientele to over eight lakhs. The growth of Chola can be attributed to our ground level understanding of the customer's profile and their credit needs, which helped us to innovate and customize products to suit their needs. With better product lines, lower cost, wider and effective reach, strong risk management capabilities to check and control bad debts and better understanding of our customer segments helped us not only achieve success in vehicle finance business, but we have also managed to build substantial assets under management (AUM) in the housing finance sector. At Chola, integrity, passion, quality, respect and responsibility are our five lights and all our actions are governed by these guiding principles. All the above have enabled us to grow from an equipment financing company to a comprehensive and full-fledged financial services provider.

In your opinion, which factors were the absolute drivers of growth for the company? 

Strong pan-India presence, key focus on rural and semi-urban sectors, well-diversified portfolio of asset financing products, experienced management team with unrivalled industry experience, strong backing and exceptional lineage from the Murugappa Group.

What were the key growth challenges faced by your company at the initial stages? 

Initially, we were concentrated in South and our operations were limited to few products and geographies. Dependence on banks for funding and limited access to capital market was also a hurdle. The financial sector reforms in the early 90s, liberalisation of regulatory control over markets, institutions and instruments, along with rationalised regulatory framework in 2000s enabled NBFCs to function as a catalyst to economic development of the country.

What are the major strategies of the company that have helped it grow over the years?

Positioning Chola as a strong asset financing company, creating business value through technology innovation, strong dealer and manufacturer relationship, highly experienced and stable team and customized product offerings for our target customers.

How do you compare the business environment today to the environment in 1980s when it was early days for your company? 

The business environment in the 1980s was very restrictive for NBFCs because of the non-availability of instant credit and regulatory restrictions, while the current business environment and the Industry outlook is very encouraging. NBFCs play an important role in nation-building and financial inclusion by complementing the banking sector and reaching out credit to unbanked segments of the society. Going forward, the latent credit demand of an emerging India will allow NBFCs to fill the gap, especially where traditional banks have been wary to serve.

Additionally, improving macroeconomic conditions, higher credit penetration, increased consumption and disruptive digital trends will allow NBFCs' credit to grow at a healthy rate. The RBI is constantly striving to bring necessary changes in the NBFC regulatory space to proactively provide regulatory support to the segment and also to ensure financial stability in the long run.

In the current environment, alternative credit scoring methods are used on multiple data sources, which enables informed underwriting, thereby reducing default rate and providing instant decision-making. This improved underwriting practice enables in financial inclusion and has the ability to reach a diverse and widespread audience. This was not the scenario in the 1980s as the credit manager had limited data for evaluating the credit worthiness of the customer.

In the journey so far, has there been any shift in vision and mission of the company? 

There has never been any shift in vision and mission of the company. The vision of Chola is to enable customers enter a better life. Ever since its inception and all through its growth, the company has kept a clear sight of its values. The basic tenet of these values is a strict adherence to ethics and a responsibility to all those who come within its corporate ambit - customers, shareholders, employees and society.

"Initially, we were concentrated in South and our operations were limited to few products and geographies. Dependence on banks for funding and limited access to capital market was also a hurdle."

Methodology of Picking up 400 Small-cap Stocks 

To emerge with "400 Small-Caps" we have considered four factors. First factor is related to market data i.e. market capitalization; second and third factor is from profit and loss account that are sales and net profit; fourth is return to investors in terms of dividend. We ranked every data and then gave equal weight-age of 25 bps points to each parameter so that ranking does not get tilted due towards any one factor. One could wonder why we have taken dividend as one of the parameters. This is to safeguard that investor friendly companies should represent in our "400 Small-Caps" list. It also gives effect of different face value. We took dividend as a percentage to ensure that face value (FV) of 1 or 2 put them at disadvantage over companies having face value (FV) of 10. Since we have run the query in first week of August 2017, all the data available of the companies during that period has been comprised in our study. (All the financial data are sourced from Dion Global Solutions Ltd.)

20 MICRONS LIMITED 

BSE CODE : 533022 Face Value : Rs.5
CMP : Rs.37.90 Market Cap : 60.18 F F (Cr.) 

20 Microns Limited is engaged in the production and trading of industrial minerals. The company's business segments majorly include micronized minerals. The micronized minerals segment includes products such as calcined clay/ calcined kaolin, china clay/kaolin, natural redoxide, natural silica, natural mica, natural baryte, natural ground calcium carbonate, natural talc, and nepheline synite/feldspar. Its products also include specialty chemicals such as white pigment opacifier and speciality matting silica, among others.

On the financial front, the company's revenue dropped 4.30 per cent to Rs.97.37 crore in Q1FY17 as compared to the same quarter of the previous fiscal. The company's PBIDT fell 18.90 per cent to Rs.12.16 crore in the first quarter of FY18 on a year-on-year basis. The company's profit after tax declined 37.24 per cent to Rs.3.13 per cent in Q1FY18 as against Rs.4.99 crore in Q1FY17. On an annual basis, the company's net sales rose 6.78 per cent to Rs.371.68 crore in FY17 as compared to the previous fiscal. The company's PBIDT rose 17.17 per cent to Rs.48.53 crore in FY17, as against Rs.41.42 crore in FY16. The company's profit after tax increased 35.97 per cent to Rs.12.70 crore in FY17 as compared to Rs.9.34 crore in the previous fiscal.

The company's TTM PE stood at 8.92x as against the industry PE of 12.33x, while the company's peers such as NMDC maintained a TTM PE of 15.64x and Sandur Maganese Iron Ore's stood at 18.33x. The company is likely to gain significantly as an outcome of improved demand scenario and greater stabilisation in government regulations. The company has also witnessed significant rating upgrades in recent times.

ATLANTA LIMITED 

BSE CODE : 532759 Face Value : Rs.2
CMP : Rs.90.50 Market Cap : 221.27F F (Cr.) 

Atlanta Limited, the India-based construction company, is engaged in the business of contracting activities, such as the construction and development of infrastructure. The company's business is based on engineering, procurement and construction (EPC) basis and public private partnership (PPP) model on build, operate and transfer (BOT) and design, build, finance, operate and transfer (DBFOT) basis.

The company is engaged in the construction of roads, highways and bridges, among others, on BOT and DBFOT basis. The company has a growing presence in mining of coal and limestone, infrastructure segment, mining, realty and tourism infrastructure segment in India with several BOT and PPP projects in its name. In the tourism infrastructure segment, the company's major subsidiaries include Atlanta Infra Assets Limited and Atlanta Tourism Ventures Limited, among others.

On the financial front, Atlanta Limited posted 8.01 per cent decline in its revenue to Rs.76.44 crore in Q4FY17 from Rs.83.09 crore in Q4FY16. However the company's PBIDT rose 76.80 per cent to Rs.39.53 crore in the fourth quarter of FY17 on a yearly basis. The company's profit after tax rose 64.15 per cent to Rs.21.58 crore for the corresponding period.

On an annual basis, the company's revenue rose 65.22 per cent to Rs.224.48 crore in FY17 as compared to the previous fiscal. The company's PBIDT rose 280.30 per cent to Rs.135.73 crore in FY17 on a yearly basis. The company's profit after tax rose tremendously from Rs.3.34 crore in FY16 to Rs.82.44 crore in FY17. The company's TTM PE stood at 9.61x, starkly undervalued against the industry PE of 25.79x. The company's peer Brahmaputra Infra maintained a TTM PE of 141.98x.

INDIAN HUME PIPE COMPANY 

CMP : Rs.556 Market Cap : 808.32 F F (Cr.) 

Indian Hume Pipe Company Limited is engaged in the business of construction and maintenance of projects relating to water supply, irrigation, sanitation and sewerage systems as well as manufacturing pipes. The company majorly operates through construction contracts, among other segments, with the construction contracts segment including water supply schemes, pipes supply and laying projects. The company also has a strong presence in other segments, including railway sleepers, air rifles, development of land and other miscellaneous items.

On the financial front, the company's revenue rose 63.92 per cent to Rs.494.36 crore in the fourth quarter of FY17 on a year-on-year basis. The company's PBIDT increased 127.24 per cent to Rs.63.50 crore in Q4FY17 as against the same period in the previous year. The profit after tax of the company increased 252.60 per cent to Rs.33.24 crore in Q4FY17 as against Rs.9.43 crore in Q4FY16.

On an annual basis, the revenue of the company increased 90.19 per cent to Rs.1810.13 crore in FY17 as against the previous fiscal. The company's PBIDT also rose 114.09 per cent to Rs.207.58 crore in FY17 on a yearly basis. The net profit of the company increased 239.48 per cent to Rs.98.79 crore in FY17 as compared to the previous fiscal. The company's TTM PE stood at 27.09x as against the industry PE of 25.79x, while the company's peers, IL&FS Engineering and Construction maintained TTM PE of 16.72x and KNR Construction's PE of 14.99x.

PRIMA PLASTICS LIMITED 

CMP : Rs.239 Market Cap : 110.30F F (Cr.) 

Prima Plastics Limited manufactures plastic moulded articles, including designing and manufacturing plastic moulded furniture such as chairs, baby chairs, dining tables, stools and tea-poys in a range of colours. The company majorly operates in the plastic moulded furniture. However, it has a strong presence in the aluminium composite panel as well. Prima Plastics' manufacturing units are located at Daman and Kerala. These units meet the strong export demand in the markets of United States, Africa and the Middle East. On the domestic front, the company markets its products in Coimbatore, Delhi, Hubli, Jammu, Jaipur, Kanpur, Rohtak, Bhiwandi, Ongole, Telangana, Vapi and Zirakpur. The company's clientele include hotels, restaurants as well as households for swimming pools and gardens in both domestic and international markets.

On the financial front, Prima Plastics Limited posted 10.01 per cent drop in its revenue to Rs.26.53 crore in the fourth quarter of FY2017 as compared to the same quarter in the previous fiscal. The PBIDT of the company fell 13.90 per cent to Rs.2.97 crore in Q4FY17 on a year-on-year basis. The company's profit after tax dropped 25.59 per cent to Rs.3.02 crore in Q4FY17 as against Rs.4.05 crore in Q4FY16.

On an annual front, the company's revenue dropped 6.26 per cent to Rs.95.69 crore in FY17 as against Rs.102.08 crore in FY16. The company's PBIDT fell 15.12 per cent to Rs.8.70 crore in FY17 on a yearly basis. However, the company's profit after tax rose 1.35 per cent to Rs.9.76 crore in FY17 on a year-on-year basis. The company's TTM PE stood at 28.37x, as against industry PE of 27.57x, while the company's peers, Hindustan Adhesive maintained a TTM PE of 16.72x and Mitsu Chem Plast PE of 14.99x.

YASH PAPERS 

CMP : Rs.39.25 Market Cap : 82.99F (Cr.) 

Yash Papers Limited provides consumer, industrial and protective packaging solutions, besides manufacturing low grammage machine glazed (MG) industrial bleached and unbleached grades of paper. The total paper production capacity of the company is of about 39,100 metric tonnes per annum, with pulp mill capacity of over 130 tonnes per day, whereas its chemical recovery unit has a capacity of about 140 bone dry metric solids.

On the financial front, Yash Papers Limited posted 1.60 per cent rise in its revenue to Rs.46.64 crore in the first quarter of FY18 on a year-on-year basis. The company's PBIDT rose 30.74 per cent to Rs.8.98 crore in Q1FY18 as compared to Rs.6.87 crore in the first quarter of FY17. The PAT of the company increased 144.63 per cent to Rs.2.94 crore in the first quarter of FY18 on a yearly basis. On an annual basis, the company's revenue increased 0.28 per cent to Rs.173.81 crore in FY2017 as compared to the previous fiscal. The company's PBIDT rose 21.02 per cent to Rs.31.21 crore in FY17 as against Rs.25.79 crore in FY16. The company's profit after tax rose 124.21 per cent to Rs.6.39 crore in FY17 as compared to Rs.2.85 crore in the FY2016. The company's TTM PE stood at 16.90x, as against the industry PE of 10.98x. The company witnessed a significant traction in its earnings and is intensely making substantial investments and technology upgradation for the expansion of its operations.