Are there opportunities or risks in small-cap stocks?

Are there opportunities or risks in small-cap stocks?

Companies with a market capitalisation less than Rs. 500 Crore are categorised as small-cap companies. Over 95% of Indian companies are considered as small-caps.

Small cap stocks have been on a downtrend for the most part of the last two years. When the economy faces challenges, usually midcap and small cap stocks are impacted the most while mature large cap stocks remain steady.

As per SEBI guidelines, the 251st company onwards in terms of market capitalisation (market capitalisation=shares issued multiplied by market price) are termed as small cap stocks. These companies are usually on the growth stage of the business cycle and those with a key advantage such as innovative products, patents, technology edge, etc. have the potential to grow multi-fold over the long term.

With the Covid-19 related lockdown being lifted, the economy is seeing a revival. This situation is promising for quality small cap stocks. Investors entering these stocks will see a dual advantage of investing at very low valuations with the added advantage of multi-fold growth potential. High dividend yields and low price-to-book ratio are indicators that small cap stocks are currently available at very attractive valuations. With the Indian economy expected to step up its growth rate, small caps are expected to benefit more than large cap stocks.

We believe there are 3 key reasons for small caps to become multi-bagger stocks going forward:

• The lockdown has resulted in weaker companies shutting shop thereby leaving a gap for stronger players to grow their market share.
• With the government and RBI facilitating borrowing at low interest rates, are an indication that smaller companies will have access to cheap liquidity for growth.
• When the business cycle turns northward, small cap stocks usually see a greater rebound compared to mature companies.
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The long-term view holds that small-cap value stocks will benefit from sustained, long-term economic growth – which to us, is the base case for the Indian economy.

We strongly recommend taking this opportunity to allocation some portfolio of your equity portfolio into small cap stocks to enhance your portfolio returns.