Indian Stock Market: Is the collapse of small cap stocks an opportunity for bottom fishing?

Seen as the main beneficiaries of South Asian countries' more than 8% economic growth, small company stocks are expected to make a comeback after a sell-off that sent the Nifty Smallcap 250 index down nearly 10%. since February 27. and the Exchange Board of India (SEBI) has directed mutual funds to take steps to protect investors from speculative froth in small and mid-cap stocks.

The rout follows a meteoric run that has seen the value of small caps rise by more than $230 billion since March last year, driven by robust profits and relentless inflows from India's army of retail investors . Even if valuations remain elevated, buyers with a sense of history say bouts of tumult like this are common in a bull market and tend to prompt a shift toward quality.

This is undoubtedly an opportunity to acquire high quality, well-managed companies at more attractive prices,” said Mike Sell, head of global emerging equities at UK-based Alquity Investment Management Ltd. “Nothing has fundamentally changed, while recent corporate comments show a stronger picture than is perhaps widely appreciated.”

Morgan Stanley said earlier this week that India's current economic expansion resembles the boom period of the mid-2000s, when growth averaged above 8%. At that time, a small-cap index managed by BSE Ltd. rose more than 1,200%, an ascent that was marked by several periods of short-term corrections.

The measure relating to small capitalizations of the National Stock Exchanges was introduced much later. It has experienced two corrections of 27% and 14% since March 2020, only to rebound strongly over the next six to 12 months.

This shake-up is very welcome,” said Deven Choksey, managing director of DRChoksey FinServ Pvt. in Mumbai. “Investors will not mind this correction.”

Certainly, valuations remain high despite the decline. The small-cap index trades at nearly 21 times one-year forward earnings, compared to a five-year average of 18 times. That's prompting some strategists, including those at Goldman Sachs Group Inc., to recommend a shift to India's biggest companies.

Small-cap stocks appear crowded with domestic ownership at multi-year highs,” the U.S. bank said in a note on Friday. We continue to favor large caps and expect further rotation into quality pockets this year.”

Bulls say small companies' soaring returns come from strong corporate profit growth in recent years. Earnings among members of the NSE's small-cap gauge have more than doubled since 2022, outpacing the index's 40% jump during the period, according to data compiled by Bloomberg.

As stocks extended losses this week, domestic and foreign funds benefited from the declines. Flush with cash, local funds pumped a record $1.1 billion into stocks on Wednesday, as small- and mid-cap indexes suffered their worst selloff in more than two years.

Read more: Global funds spark excitement as Indian minnows look for winners

Volatility like what we've seen this week provides exceptional opportunities for investors,” said Andrei Stetsenko, partner and portfolio manager at New York-based Farley Capital LP. I wouldn't be surprised if other foreign funds present in Indian mid and small caps were, like my company, significant net buyers in recent days.

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This story was published from a wire feed without modifications to the text. Only the title has been changed.

Published: Mar 16, 2024, 07:43 IST