Analysts remain bullish on small-caps despite index hitting record high

Small-cap stocks have been on a roll since the past few months with the S&P BSE Smallcap index hitting a record high of 20,290 points in Thursday’s intra-day trade. The index surpassed its previous high of 20,183 touched on January 15, 2018 in intra-day deals.

Despite the index hitting record levels, analysts see more headroom for the stocks in this segment as the economic recovery gathers steam, which they believe, should be beneficial for companies in the mid-and small-cap space. Moreover, the accommodative stance of most global central banks amid low interest rates will ensure that money continues to flow into emerging markets (EMs), including India. Though there can be an intermittent correction, stock selection will be key, they say.

“There is ample liquidity all around with global central banks remaining in an ‘accommodative’ mode. With the economy opening up, companies are back in business and the demand for products is steady. All this augurs well for companies, especially in the mid-and small-cap segment. That apart, the retail investors have latched on to the small-caps and are partly responsible for driving up prices,” explains G Chokkalingam, founder and chief investment officer at Equinomics Research.

With the rise in markets and having tasted success, most experts believe that the interest of retail investors in the markets, especially the small-caps is here to stay – at least for now.

“When retail share of equities trading went up from 50-55 per cent to 65-70 per cent in May-2020, it was widely believed to be driven by forced savings during the lockdown and availability of free time. However, even after the economy has more or less opened up, activity levels have not reduced and growth in demat accounts has in fact accelerated to 30 per cent YoY from 10-15 per cent a year back. It thus appears likely that direct retail participation in equities would persist for a while,” wrote Neelkanth Mishra, managing director, India Strategist and co-head of equity strategy for Asia Pacific at Credit Suisse in a February 23 co-authored note with Abhay Khaitan and Prateek Singh.

Among stocks, Majesco, Hindustan Copper, Magma Fincorp, IIFL Finance and OnMobile Global have more than doubled in the past one month alone. The public sector banks like Bank of Maharashtra and Indian Overseas Bank have zoomed 87 per cent and 77 per cent, respectively on privatization buzz.

“Only 10 per cent of retail portfolios are in sub-$1 billion stocks, but their share of ownership (24 per cent) of these is larger than that of $1 billion-plus stocks (13 per cent). With 54 per cent of free-float of the sub-$1 billion stocks, elevated retail activity should be supportive of small-/mid-cap stocks and indices. As economic revival gets more broad-based, these firms should also get earnings support,” Mishra wrote.

Since their March lows, the frontline indices – the S&P BSE Sensex and the Nifty 50 – have surged 92 per cent and 94 per cent, respectively till date. The rally in the mid-and small-caps has been sharper with both these indices rallying 106 per cent and 128 per cent, respectively on the BSE during this period.

That said, experts do caution against the overall market valuation at this stage. Besides, rising commodity prices and bond yields remain one of the key risks for the markets. A clear risk emerging from the December 2020 quarter earnings season, according to analysts at UBS, is the concern about rising commodity costs. Companies, they said in a recent note, are worried about rising prices of crude, crude derivatives, metals, palm oil and tea, among others.

“I would still remain more comfortable with large-caps than small-and mid-cap stocks due to excessive volatility, inadequate ESG disclosures / strategy and risk from variation in overall economic growth / interest rate environment. However, there are always good exceptions,” says Jigar Shah, chief executive officer, Kimeng Securities India.