Recent news about small and midcaps has focused on broader markets. Especially following the recent Securities and Exchange Board of India (SEBI) guidelines for multi-cap funds.
Although the situation is still developing little is known about the money that can be converted into small-caps. But investors need to remember a few things before pressing the buy button.
Last week, SEBI brought in new rules for portfolio allocation for multi-cap funds. By January 2021, these funds must invest at least 25 per cent of their portfolio. In large-cap, mid-cap, and small-cap stocks.
Currently, most multi-cap funds have a clear large-cap bias. Data shows that the vast majority of these funds have a single-digit allocation of 70 per cent in large-caps. 15 per cent in midcap, and small caps space.
Brokerage houses in small and midcap space come out with picks of their choice. It makes it easier for investors to make their decision. But they also have to do their homework.
“Post the SEBI circular and the clarification, buying in smallcap and midcap is expected by traders in anticipation of fund buying that can come later once they finalize their strategies. This buying can sustain for a couple of days and then if the institutions don’t turn up to buy. Traders can get impatient and start to unload their positions.” Deepak Jasani, Head of Retail Research, HDFC Securities said.
A lot will depend on how reasonable the valuation of these stocks remains to attract long-term buying from institutions. Mutual funds have expressed their hesitation in buying small and midcaps just to meet the SEBI requirements. Without getting convinced about the stocks or their entry valuations,” he said.
Here are five factors that experts want investors to keep in mind before pressing the buy button:
Many mid and most small-caps don’t have adequate liquidity in terms of daily turnover in the exchanges, say experts.
“The average daily turnover of many small-caps below Rs. 5,000 crores market cap is around Rs. 2 – 3 crores only and hence the impact cost in most of them is high,” Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities said.
“Another important factor to keep in mind when it comes to midcaps is analyst coverage. FIIs and DIIs prefer regular post-result conference calls, analysts meet and companies widely covered by brokerages,” he said.
In the case of small-caps, companies that fall in the Nifty Smallcap Index should ideally prefer those that are known and actively covered.
Avoid herd mentality
Mutual funds have expressed their reluctance to buy small and midcaps to meet SEBI requirements and retail investors should follow a similar checklist.
“It hurts investors to join the buying side without enough faith in the story,” said Jasani of HDFC Securities.
SEBI lifts prescription P/E ratio by a few percentage points for better mid and small-caps; If the run-up is too sharp and the story is not convincing, the stock price runup may come out soon, he said.
Do your own research
Investors may take suggestions from what mutual-fund managers buy or sell. But the final decision should be based on their research. Research about the company and management and the company’s product basket.
“Smart investors who analyze balance sheets, financials, and companies can venture on their own in small unknown companies,” Oja said.
“The promoter should do some basic homework on hygiene factors such as holding, promised shares, ratios, cash flows, debt-equity ratio, and values before taking any further exposure in any mid or small-cap company.” He said
Focus on 5GCPM framework
The change in the multi-cap allocation policy for mutual funds will be somewhat towards the small-caps and slightly towards the midcaps. To bet high confidence, experts say the company’s revenue growth should continue for a few quarters.
“Investors should focus more on the size of the opportunity, higher revenue growth, and the implementation capacity of the management, which will focus on our 5GCPM framework,” said Pritam Deuskar, Founder of Wealthyvia.com.
“Substantial wealth is only created when your small or midcap stock becomes a large-cap. The Forbes list changes a lot every five to seven years. Most companies grow, ”he said.
5GCPM is a method developed by semantic growth analysis:
- 5 types of growth in company business
- Check corporate governance
- The practicality of the investment is fruitful and
- Magic parameters that tell about the basic and technical long-term trend.
Focus on earnings
Most small-cap companies do not fall under the category of analysts, so investors should take care of themselves before investing.
As fund managers begin to equate with new guidelines, low backflow in the wider market will increase investor interest in small and midcap stocks.
“The retail investor plans to put the money into a wider stock, keeping in mind the basics of the business, the credibility of the management, and the past track record of the company’s relationship with other shareholders,” said founder Dinesh Rohira, CEO – 5nance.com.
“It is important to remember that strong business drives the price of a fundamental firm and not a market-cap classification. It is equally important to check the liquidity of stocks in the market when buying companies,” he said.