Small Cap Stocks

Why is Mark Mobius bullish on Indian small cap stocks?

Small and mid cap stocks were the toasts of 2015. In a year when the indices gave negative returns, mid and small cap stocks vastly outperformed. However, the scenario has changed drastically post the Union Budget 2016. While large cap stocks have given returns in excess of 15% post the Union Budget, most mid and small cap stocks have given negative returns. It is in this context that Mark Mobius’ allocating 30% of his India portfolio to mid-cap stocks is significant. But he has a point!

They are back in comfort zone… 

Post the rapid rise of mid cap and small cap stocks in 2015, most analysts had expressed concerns that the valuation gap between large and small cap stocks had become unfavorable. The reversal in the last 3 months puts that valuation gap in a much better perspective. Many of the large cap stocks in India are currently quoting at rich valuations or their earnings and revenues are either stagnating or growing too slowly. This means that most mid cap and small cap stocks would be back in the comfort zone as far as margin of safety is concerned.

Benefit of cheap commodities… 

India has been talking about the dividends of cheap oil for over 2 years and only now the impact is visible in large cap companies in the form of improved operating margins. But small and mid cap companies, due to their focused business models, could derive the benefits of cheap commodity prices much earlier. Over the last 6 quarters, this has resulted in consistent growth in profits for small and mid cap companies. Most of these mid and small companies are also low on leverage as a result of which their financial vulnerability is far lower than the large cap stocks. This again makes them attractive from an investment perspective.

Beneficiaries of reforms…

Historically, the small and mid cap companies have been the biggest beneficiaries of the reforms process. Companies like Infosys, Hero Honda, Bharti and Sun Pharma transformed from mid cap companies to large companies purely because they could leverage on the reforms process much better. Typically, the early movers in any industry are the small and mid-sized companies as they have the flexibility to leverage the reforms process. This is what creates large cap companies.

There are 2 other key factors to remember. The recent SEBI stricture on P-Notes has flushed a lot of dubious small-cap stocks out of the market. Secondly, greater regulatory oversight has ensured that mid-cap companies increasingly play by the rules of the game. Mark Mobius may actually be on target. The real value in Indian markets does lie in small and mid caps! ©

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