Small stocks, big gains

How do people with a passion for investing in small and micro-cap stocks go about choosing their stocks? Maulik Madhu sounds out some investors

If investing in the stock market requires an appetite for risk, then one must have a voracious appetite when it comes to investing in small and micro-cap stocks. Putting money into stocks with market cap of a few hundred crore and under is not for the faint-hearted. These stocks come attached with high risks. A wrong bet here could burn your fingers badly.

But, these stocks also hold the potential for high returns. Take 2015, for instance — even as the Sensex lost 5 per cent, the BSE Small Cap Index went up 6 per cent. And in 2014, while the Sensex gained 30 per cent, the BSE Small Cap Index surged 67 per cent.

We spoke with some people who have a passion for investing in small and micro-caps. Here’s what they said about their stock-picking strategies.

Number crunching

While you may marvel at and envy the handsome gains made by many on the stock markets, what you’re probably missing out on is the hard work that went into it. Going through a company’s annual report, quarterly results and its website are an obvious starting point. But there’s more to it.

“I look at a company’s last five-year annual report, what the management said versus what they actually achieved and who are the company’s competitors in the market,” says Jiten Parmar, a businessman who has been investing in the Indian stock market since 2000.

Keeping a close tab on every company announcement, too, is very important. “You can’t buy a small-cap stock and go to sleep,” says Rajeev Jawahar, a full-time investor since 2010.

For him, as for many other investors, the fundamental reason for investing in a small-cap company is its potential for high growth. “I look for companies with at least 20-25 per cent top-line growth. This, along with operating leverage, should result in 30-35 per cent growth in profits, which ultimately gets reflected in the share price,” says Rajeev.

Ravi Padmanabhan, an ex-Citibank employee and now a full-time investor, looks for 20 per cent (CAGR) revenue growth over a three-year period, given that small-cap companies may not show consistent growth.

Another factor that these investors closely follow is change in promoter shareholding. An increase in the promoter’s stake and share buy-backs are big positives, says Rajeev.

The transparency with which the company management communicates with shareholders, the dividend payout ratio, brand value and the ROCE are the other criteria these investors take into account.

While the stock valuation is important, it may not always drive stock purchase decisions. “I bought Eicher Motors, about seven years back. The company has done well and should continue to do so as it is considering export options. The stock is expensive but I still hold it,” says Jiten.

Beyond numbers

Investors such as Jiten also make enquiries with dealers to get a sense on how well the product is selling. Anand Mohan, another stock market buff, who largely invests in stocks with market capitalisation of up to ₹50 crore, too, follows a similar approach. Anand first bought the stock of Butterfly Gandhimathi Appliances at ₹7 in 2007-08 and then continued to accumulate it. At one point in time he was holding 1 per cent stake in the company. He then sold a few shares in 2011 and 2012 and the remaining in 2013, after the stock hit ₹380.

But, it was not sheer chance but solid research that fetched him handsome returns.

His investment in the stock was preceded by a drive around the company’s factory in Chennai, enquiries at appliance stores and feedback from friends’ mothers.

“The company was improving and was launching new products. But, the stock was still available at throwaway prices, so I pumped in all my savings into it,” recalls Anand.

Similar was the case with Q-Flex Cables (now Cybele Industries). “Based on a casual ride around the Q-Flex Cables’ factory site, I learnt that the company had sold off the factory. Since real estate was booming then, I felt that the company would consider selling off its land. The land was worth ₹70-75 crore, but the company’s market cap was only ₹3-4 crore. So, I bought the stock at about ₹6 each.

The company announced a joint venture with Vijay Shanthi Builders and in a year’s time, the stock went up to ₹40, and I sold off the stocks,” says Anand.

But if collecting information requires effort, taking a call on a stock requires firm conviction.

Conviction matters

“Most people are unwilling to take a call and are happy to follow others. There will always be negatives to a story, but you must have the self-belief to take a call with the knowledge that you may still go wrong. Take a calculated call and then if it goes wrong, so be it,” says Rajeev.

Many calls will go wrong but what matters is, the gains should outweigh the losses. For Rajeev, 80 per cent of gains have come from 20 per cent of his stocks. He lost money on textile and commodity stocks. Among the stocks that didn’t work for Ravi was MIC Electronics; for Jiten it was Assam Company. They sold these stocks at a loss. But, as Rajeev says, “Cutting losses is important; how else will you get liquidity?”

Patience is another virtue by which all of these investors swear. Jiten takes the case of SRF, which he bought in 2010 at ₹360 a share, to drive home the point.

“Nothing happened to the stock for a few years. When it fell, I bought more shares. Finally, the market turned around and I sold off some shares in 2015 at ₹1,400,” recounts Jiten. He also holds Consolidated Finvest & Holdings, which hasn’t given any return in five years. But he still has the stock, he feels it has a lot of value yet to be unlocked.

So, do your homework, stay alert, and swoop in at the right time. That’s how market killings are made.

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