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Matthew 7:7,8 Ask, and it shall be given you; seek, and ye shall find; knock, and it shall be opened unto you: For every one that asketh receiveth; and he that seeketh findeth; and to him that knocketh it shall be opened.

15 Nov 2015


Hi Friends,  Is it a good strategy to pick Small Cap shares for investment?

You may be thinking about to invest in small cap companies.  Though they are rarely on the top of investors’ priority list they can give very good returns, provided  they are chosen with care.  The Bombay Stock Exchange (BSE) small-cap index fell over 20%.  However the benchmark, the BSE Sensex, rose 0.15%.  While small cap stocks can give big gains, the losses , too, can be huge.  Small-cap stocks are not tracked closely by market analysts and that is why the real value of good small cap stocks can remain undiscovered for long.  This makes investing in them risky.  But the rewards of finding a hidden gem are huge too, for such a stock may become a mid cap or even a large cap stock over time, giving superlative returns.  Twenty (20) percent is the fall in the Bombay Stock Exchange Small cap index.  However, select small-cap stocks have given stellar returns. “ Small cap stocks are like trees that have just been planted.  Obviously, they will take a few years to grow and blossom.  

They can be good bets for the long term,” says Gokul Raj P, executive director and head, investments, HBJ Capital Services.  On the flip side, small cap stocks have a low equity base, which is why selling/buying can take time.  If one buys a wrong stock, a prompt exit is difficult.  Also, many small companies are young, with a very short track record.  Hence, judging their performance is difficult.  Small companies are relatively weak in terms of governance, dividend policies and professionalism of the board.  This makes them risky.  When times are tough, large companies sail through, but the smaller  ones are at the receiving end.  Small companies are struggling with high borrowing costs, low demand, power shortage, and high wages and commodity prices.  Most companies are being forced to either sell assets to pay off loans or pledge shares to raise funds.  Higher imports from China and currency volatility are also putting pressure on margins.  Small cap stocks are like trees but that have just been planted.  Obviously, they will take a few years to grow and blossom.  Now, let’s look at some aspects that need to be looked at while buying small caps stocks.

Track record of Promoters:  The first thing one must check is for how long the promoters have been in the business and whether they are backed by a strong team.  “Usually, we have a face-to-face talk with the management and visit the facilities of the company before recommending a penny or small cap stock.  Hosever , retail investors have no option but to rely on research reports on this count.

Promoters’ stake:  A high promoter stake shows his confidence in the business.  You should also ask if  the promoter plans to increase his stake. “ One has to be extremely  cautious while investing in small cap companies. Attributes such as promoter holding, shares pledged, return on equity and debt-to-equity ratio should be considered carefully.”

Business Model:  A unique and robust business model augurs well for the company in the long run.  If a small company is present in areas dominated by those with deep pockets, then chances are that it will close shop sooner than later.  Small firms are relatively weak in terms of governance, dividend policies and professionalism of the board.  This makes them risky.  High debt of the company means the interest outgo is huge, which can be a big drag.
Institutional holding:  Experts say institutions avoid buying shares of small companies due to lack of liquidity.  But if you come across a small company in which institutions have bought stakes, you need to take the stock seriously.  But be careful, as institutions can also take wrong calls.

Investment Options:  There are 509 stocks available for trading in the BSE Small Cap index.  Out of them, 11% are from the capital goods sector, followed by finance (10.7%), housing (9.75), metal and mining (5.73%) and health care (5.39%).  Small  cap pharmaceutical, FMCG , information technology and banking stocks can give good returns.  However identifying small cap stocks is more of a bottom-up exercise (being stock-specific) rather than a sector-specific call.  Investing in Good Small Cap shares in Long term definitely  give excellent reward.  But utmost care needed for selection.  Investors refer previous posts in this site for further study and selection.

Good Luck.                                                               See You Later. 

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