Skip to main content

On The Radar: India's Small-Cap Equities (Concluded)

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.  


Post a Comment

Popular posts from this blog

Under The Radar: India’s Small-Cap Equities (Part Three)

In February of this year, we summarised the valuation parameters of the BSE Small-cap Index in India (now the S&P BSE Small Cap Index) - following on from an earlier report we wrote in December, 2011 - and drew certain conclusions. We would like to update the valuation scenario with the data today, review those conclusions, and form new ones based on the available information. The small-cap index closed today (17 th December, 2013) at 6,150.65 with an indicated price to book value of 1.04. The closing value as on February, 2013 was 7,006.73 representing a decline of over 12% as of today. The current index value masks a greater fall of over 27% to a low of 5,085.56 in August, 2013. This represents an unsatisfactory overall performance for those who invested in small caps at the beginning of the year. In our earlier report, we made two assumptions towards the end of our report to form a conclusion as to prices then:              1)   “The market has a

Under the Radar: India's Small-Cap Equities (Part Two)

About a year ago, we analysed the valuation of India's small and mid-cap indices to determine whether they were attractive for purchase by investors (see post below). Our analysis revealed that the indices appeared undervalued by historical standards. We decided to have another look at the current valuations of the indices to recap performance and determine the price attractiveness today. When we wrote our post last year, the small-cap index closed out at the level of 5,550.14. The closing level today is 7,006.73 – resulting in a gain of over 26% in a little over a year. So, how does this level stack up against the basic fundamental metrics of the underlying businesses?  Here’s a summary of the valuations sourced from the BSE website: Table 1: Annual valuations (2006 to 2012) Year High Low Close Price/ Book value 2006     7,872.80    4,480.45     6,892.32            2.05 2