NEW DELHI: Smallcap stocks are plunging like a falling knife. Nine of every 10 stocks in the 860-member BSE Smallcap index are currently trading in the red.
As many as 57 of them have lost 50-90 per cent of value from their January highs while 268 others have lost over 30 per cent. The sharp fall in this pack has caught small investors off guard. Retail investors usually tend to like these stocks for their low prices.
Analysts say earnings disappointment was one of the key reasons that have made retail investors and HNIs bail out of many midcap and smallcap stocks.
A major rejig in Sebis classification of equity mutual fund schemes have also taken a toll on midcap and smallcap names, as the market regulator has sharply lowered the share of total portfolio that largecap-oriented funds can invest in midcaps or smallcaps.
Prevailing macroeconomic challenges such as a rising crude oil prices, a weakening rupee and emerging political uncertainties in the runup to the 2019 general elections have also unnerved investors and made them steer clear of too risky options.
But analysts still believe there is money to be made in many smallcaps, but one has to be extremely stock-specific.
“We had a situation where the midcap and smallcap indices were trading at about 40-50 per cent premium to the largecap index. We have not seen a follow through in terms of earnings in a lot of these names,” said Pankaj Murarka, Founder at Renaissance Investment Managers.
He said the growth expectation that was priced into a lot of midcap and smallcap names were too high, and there was a degree of froth in the way retail and HNI participation was happening in this space. It is largely unwinding.
On a trailing 12-month basis, the BSE smallcap index trades at PE of 85 times, even after correcting 15 per cent from its all-time high of 20,183 hit on January 15.
Some smallcaps such as Gitanjali Gems(down 93 per cent), Diamond Power (down 88 per cent), Talwalkars Better Value Fitness (83 per cent), Electrosteel Steel (84 per cent), Bombay Rayon (83 per cent) and GTL Infra (76 per cent) have taken a big knock ever since.
Stocks like Jaypee Infratech, IVRCL, lanco Infratech, Reliance Naval and PC Jeweller have wiped out up to 70 per cent of investor wealth. Many of these stocks are either of debt-ridden companies or are mired in one or the other controversy. Besides, there are sectoral headwinds hurting some of them.
For example, sugar stocks have been falling on surplus sugar output and tumbling sugar prices in overseas markets, which make exports unprofitable. Smaller banks are falling on poor asset quality. Gems and jewellery firm Gitanjali Gems has dropped on alleged fraud by its promoters while PC Jeweller fell out of favour with investors after the promoter gifted some shares to some undisclosed relatives, triggering speculation around its shareholding patterns. Some other firms are facing debt-default proceedings.
An asset class, midcaps and smallcaps are always tricky. There are always bottom-up opportunities in a correction phase, says Gautam Chhaochharia, ED & Head of India Research at UBS.
He said there are midcaps and smallcaps, which have done well in absolute terms. “We are still underweight midcaps from a broader market perspective. But select opportunities always are always there,” he said.
It may not be correct to paint all stocks with the same brush, says Pramod Gubbi of Ambit Capital, who feels the important thing to do irrespective of whether they are largecap or smallcap is to establish if the company has pricing power.
“Inflation is rising across commodities. Several companies while demonstrating strong growth have seen margins collapse this earnings season, simply because input costs have begun to hurt. This would be an inventory build-up cycle, which happened in Q3 or perhaps Q4 last year. Given that, we are still higher on the commodity price front. I guess another 2-3 quarters of pain on the margin front is clear,” Gubbi said.
Chhaochharia says with the macro headwinds rising, small investors who made a lot of money in midcaps are booking profits.
Shankar Sharma, VC & Joint MD at First Global, says the smallcap space still offers value for long-term investors with high conviction. “Smallcaps look great from a three-four-year perspective. I continue to maintain that view. Many people talk about valuation froth in smallcaps. Yes, they have run up, but earnings growth in some of them is just off the charts. They are trading at 10-15 times one-year forward earnings or rather current years earnings,” he told ETNow.
Sharma, though, noted that what might be relevant to him may not necessary be relevant for someone else not into the market full time.
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Ratio breakdowns have a lot of relevance. In the past, such breakdowns in Metals-to-Nifty ratio in 2014, Pharma-to-Nifty ratio in 2016, Auto-to-Nifty ratio in 2014 and now the IT-to-Nifty ratio — all of them have transformed into medium-term trends. Elara Capital looks at more such breakdowns to tell you where to go and where no to.