We have been running a series of
articles titled ‘Under The Radar: India’s Small-Cap Equities’ beginning in
December 2011 - and followed up twice - with the last article in December
2013.
We would like to conclude this
series after updating the small-cap index level and returns, comparing it to our
expectations ex-ante, and analysing the current scenario. Following this, we
have also outlined where we may take this blog in the future.
The small-cap index closed at 11,087.07
on December 31st, 2014. This
compares to a level of 6,150.65 in our last article – resulting in an advance
of over 80% to date.
This is a handsome absolute
return by any standard, particularly compared to Indian government bonds, which
yielded around 8-9% for the period.
This justifies the conclusion at
the end of our previous article that “small-caps in India offer among the most
attractive bargains during any time since 2006 and certainly in the entire Indian
stock market today”.
Of course external events have
played out in our favour; but the focus of the true investor is to do his
buying carefully and let external events take care of themselves – for value
will be reflected in the financial markets eventually, as our mentor Benjamin
Graham taught several decades ago.
The major ostensible reason for
such an advance is the change of government at the centre and resulting expectations
for earnings growth. It might also be
worth bearing in mind that the depth of the slump in the latter years of the
previous regime has also contributed to such a spectacular advance.
The advance masks individual stocks
that have advanced substantially and others which have failed relatively. Even though many companies with poor
managements have participated in this rally, we have observed that there has
been some discrimination against stocks with poor governance (as is appropriate). Therefore, the advance has not been
all-encompassing.
We are unable to use the price to
book value metric to analyse the current situation as the BSE website appears
to have changed its methodology substantially – resulting in a meaningless
comparison.
From our own experience analysing
individual stocks, we can express that the number of quantitative bargains in
the small-cap market has reduced substantially – almost to the point of
extinction. This appears to be the result of earnings growth being priced into
most small-cap stocks.
The implication of the above
observation is that companies would need to achieve the earnings growth baked
into their stock prices to justify those prices.
It is beyond our competence to
judge the likelihood and extent of such growth; all that is clear is that stock
prices have incorporated a substantially cheerier consensus than last year.
We would conclude that the
small-cap index today does not offer the same possibilities of substantial
profit with low risk that it offered
at the end of last year.
This does not mean that the
small-cap index will not appreciate substantially from here; it just means that we
are not convinced that it remains substantially undervalued.
To that extent, we believe that
smaller stocks in India are now on the radar of most investors - a scenario 180
degrees from that prevailing in 2011 to 2013 - and this justifies the
conclusion of this series of articles.
This
series has revealed the considerations, actions, and vindication of a simple
value approach applied to the small-cap stock index in India over a multi-year
time period in real time.
In the future, we would like for
this blog to remain a voice for minority shareholders in India. Under this
over-arching purpose, we may comment on news that impact minority shareholder
rights, analyse certain ‘special situations’ arising from corporate
announcements (rather than market movements) that provide possibilities for
profit, and produce other articles for the general education and edification of
minority shareholders in India. In this context,
we welcome comments from our readers on matters that would help them.
Great article keep it up
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