Research shows 8X higher risk of capital loss in broader smallcap universe

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Research shows 8X higher risk of capital loss in broader smallcap universe
Credit: © Reuters.

New Delhi, Dec 10 (IANS) Research by DSP Mutual Fund shows an 8X higher risk of capital loss in the broader smallcap universe.Smaller firms can present a greater risk to investors looking for capital preservation. Historical data shows that a set of smallcap stocks with subpar fundamentals were eight times more likely to cause a permanent loss of capital to investors versus stocks from the Quality bucket, the report said.

Quality is defined as companies with better Return on Equities (ROEs), lower debt and lower variability of earnings. In fact, the Nifty Smallcap 250 Quality 50 Index has differentiated quality metrices. When a basket of ‘Quality universe’ firms is compared to the broader universe ‘ex of quality’, the quality firms have nearly double the ROEs and less than 2/3rd debt.

Small and midcap (SMID) stocks have outperformed Nifty over the last 11 months. The outperformance versus Nifty is about to hit the cyclical historical peaks, DSP Mutual Fund said.

Historically, small and midcap stocks enter a period of outperformance once they reverse from deep phases of underperformance, and perform poorly when they have high trailing outperformance. Currently, SMID stocks are not only trading with massive outperformance, but are also more expensive on a trailing basis.

Based on trailing 12M P/E ratio, the Nifty Index is trading at 21.8x, Nifty Midcap 100 Index at 31x, while the Nifty Smallcap 100 Index is at 23.5x. This opens the room for relative underperformance for small and midcap stocks, the report said.

Notwithstanding concerns about lofty valuations, smallcaps recorded their most significant monthly gain in nearly three years in November, HDFC Securities said in a report.

Nifty Smallcap 100 finished the month with a 12 per cent gain, the most since February 2021 when it rose by 12.2 per cent. After declining by 4.1 per cent in the preceding month, the Nifty Midcap 100 rose by 10.4 per cent, the most since July 2022.

Midcaps and smallcaps in general have become more expensive after the recent runup, said Vinay Paharia, CIO, PGIM India Mutual Fund.

"Weak (low growth + low quality) midcaps and smallcaps are in bubble zone and caution is advised. Strong (high growth + high quality) midcaps and smallcaps present opportunity for long-term investors. On a relative top-down basis, we are finding better upside in largecaps stocks versus midcaps and smallcap stocks," the research said.

The Nifty Index rose by 5.5 per cent during the month, underperforming the MSCI Asia ex-Japan index. Nevertheless, the mid and smallcap indices clocked close to double-digit returns, said a note by Jitendra Gohil, Chief Investment Strategist, Kotak Alternate Asset Managers.

"In terms of valuations, the Nifty Index is trading at a 12-month forward PE of 19.1, versus the 10-year average of 17.6. Overall, our investment committee maintains a neutral view on equities and believes Indian equities to remain in a range," the research said.

The 2QFY24 corporate earnings ended on a buoyant note with a widespread outperformance across aggregates driven by margin tailwinds. Domestic cyclicals such as automobiles, BFSI and cement drove the beat. Consensus forward earnings estimates for Nifty were revised upwards by 2 per cent for both FY2024 and FY2025. Real-estate and select NBFCs can continue to benefit from underlying macros and a peak interest rate environment, it added.

"Our investment committee maintains a neutral view on equities in terms of overall asset allocation and believes any significant correction should be used as a buying opportunity. Given the solid macro backdrop, we expect the Indian equities to scale new highs in the coming weeks and may remain well supported," the note said.

"Despite the sharp run-up in equities, post the state election results, we continue to be positive on the long-term potential and expect the Nifty50 to deliver 10-12 per cent returns over the next 12 months," said Sujan Hajra, Chief Economist and Executive Director, Anand Rathi Shares and Stock Brokers.

"With higher-than-expected GDP growth in Q2 FY24 and strong figures posted by PMI and core industries in the middle of the third quarter, we are positive on India’s near-term growth momentum," the research said.

In November 2023, the Indian stock markets experienced a notable upturn, as evidenced by a 6 per cent surge in the Nifty 50 index, as per Motilal Oswal (NS: MOFS ) Asset Management Company’s Global Market snapshot report,

The Smallcap 250 index outperformed, leading the gains with an impressive growth of 10 per cent. Nifty Smallcap 250 rose by 10.22 per cent in November 2023 and 11.07 per cent, 33.68 per cent, and 37.31 per cent, in the last three months, six months, and one year, respectively.

Across the board, all sector indices closed the month on a positive note. The realty sector emerged as the top performer, witnessing a substantial increase of 18 per cent, the report said.

"Markets saw a smart rally of 11 per cent since the low of October end. Despite this sharp up-move, Nifty is trading at a 12-month forward P/E ratio of 18.4x, which is at a 9 per cent discount vs its long-period average (LPA). Hence, we expect focus to shift towards the largecap stocks," said Siddhartha Khemka, Head of Retail Research at Motilal Oswal Financial Services.



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