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    If you want multibagger returns from smallcaps, avoid these five mistakes

    Synopsis

    Some of the smallcap stocks have indeed rallied ahead of fundamentals, but experts say the downside still remains limited. 

    ETMarkets.com
    NEW DELHI: Smallcap stocks have been the talk of the town in last one year as they produced more multibagger returns compared with any other segment. More than 50 stocks more than doubled investor wealth in last one year compared with a 10 per cent rise in the benchmark Sensex.

    Stocks that have more than doubled investor wealth in last one year include Bodal Chemicals (up 367 per cent), Manappuram Finance (up 341 per cent), Tata Metalliks (up 324 per cent), Pricol (up 277 per cent), GNFC (up 201 per cent) and Dalmia (up 188 per cent).

    Some of the smallcap stocks have indeed rallied ahead of fundamentals, but experts say the downside still remains limited. Long-term investors can make good returns by investing part of their portfolio in smallcap stocks.

    Mark Mobius, Executive Chairman, Templeton Emerging Markets Group at Franklin Templeton Investments, reiterated his positive stance on smallcaps in an interview with ETNow on Tuesday. He said he was positive on this segment not only in India, but across Asia. The $1.2 billion Templeton Small Asian Companies Fund has outperformed the MSCI benchmark by a huge margin over the past five years.

    The five-year return has been 47 per cent compared with 12 per cent given by the MSCI benchmark. “In the smallcap space, companies that are growing have a much bigger upside because they are starting from a low base,” Mobius said.

    For consistent returns, investors should void these five mistakes while investing in smallcap stocks.

    Focus on management quality: While investing in smallcap stocks, investors should not ignore the quality of the management team. They should go through the DNA of the company or the management team at the helm to figure out the growth plans.

    "Several smallcap and midcap firms have the potential to outperform going ahead. However, one needs to pick the right stocks. Management quality is of utmost importance in these stocks,” Dipen Shah, Senior Vice-President & Head of PCG Research, Kotak Securities, told ETMarkets.com.

    Risk profile of investors: Normally, smallcap stocks are viewed as high risk-high return ideas. Accurate assessment of risk is required before investors put their hard-earned money in these stocks.

    Various parameters used include price-to-earnings ratio, price-to-book value ratio, earnings expansion or contraction, business model and projected growth rate.

    "While smallcap stocks offer wealth-creating opportunities, one should also pay attention to their valuation and inherent risks that come with it," Dinesh Thakkar, CMD of Angel Broking, told ETMarkets.com

    "It is based totally on the investor’s risk appetite. Smallcaps offer a higher reward against higher risk,” he said.

    Asset allocation is key: The aim of any investor is to create alpha. In other words, generate a return that is more than the return on the benchmark index. An ideal portfolio will be a mix of smallcap, midcap and largecap stocks.

    History shows during a period of economic expansion, like the one we are in now, midcap and smallcap companies shows better earnings growth over the a three-to-five years kind of timeframe.

    “But one should see if these are sustainable stories, which can generate high ROCEs in the future. The extent of exposure to these stocks would depend on the risk profile with the aggressive/risk-taking investors putting in a relatively higher proportion of funds into these stocks,” said Shah of Kotak Securities.

    "Ideally, largecaps should form a majority of the portfolio," he said.

    Long gestation period: Usually, for smallcaps require long gestation periods to become sustainable business models. Often, investors usually fail to identify the right business models early.

    Most of the smallcap stocks are not even covered by brokerage or research houses, which make the job even tougher. Thakkar of Angel Broking said investing in smallcaps is suggested for those who can wait until the business converts the opportunity into earnings and digest the volatility in these stocks.

    Liquidity is key when dealing with smallcaps: Generally, smallcap stocks suffer from liquidity issues, debt overhang and lack of growth avenues because of their smaller sizes and management issues. Even institutional holding is very low in most of the smallcap themes, which make trading in these stocks difficult at times. Inadequate liquidity results in investors getting stuck with these stocks as there is no buyer in the system.

    Investors who want to play the smallcap theme should analyse all the above factors and do their own research before putting in their money.



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    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
    The Economic Times

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