Since the beginning of this year, small- and midcap companies have suffered more than their bigger peers. For instance, while the Sensex fell by 52% in the first 10 months of 2008, the CNX Midcap index dropped by 63% in the same period.
Even in such volatile times, small companies present a good investment opportunity. One needs to identify small (mainly belonging to the bottom quartile of the market cap) but rapidly growing businesses which are yet to appear on the radar of investors. When these businesses grow, they will scale up quickly, doubling or trebling in two-three years. As this happens, they will benefit from improved visibility and interest from other investors.
However, these things are not necessarily going to unfold in a few months or a few quarters. The time horizon for investors in smaller companies has to be longer (about five years) than in large stocks (about three years).
Our task as fund managers is to create a portfolio of outstanding businesses, which can deliver superior and sustainable growth for our investors over mediumto-long term. We cannot avoid short-term volatility in the market and the way the market values these companies on a day-to-day basis.
When fund managers speak of small companies, these are not the ‘mom-&-pop’ variety without any business plan and experience. They refer to companies that have professional managers and are extremely agile in their operations. The most successful companies today started as small companies. Who knows where the next Reliance or Bharti is coming from?
Here are some points in favour of small companies:
• It is easier to double the sales of a Rs 100 crore company than that of a company which has Rs 5,000 crore worth sales a year.
• Small companies can ‘fly under the radar’ of intense market attention for longer. This keeps the price from being bid too high.
• Small firms can exploit opportunities that larger companies can’t afford to because of huge overheads.
So how do you find a good stock of a small company? It requires more work than investing in larger, better-followed companies since there may not be much information available. Here are some guidelines:
• Invest in what you know: If you have expert knowledge or extensive experience in a particular industry, it may be a good place to start looking.
• Be selective: Stick to quality stocks.
• Create a portfolio: Do not restrict yourself to one or two smaller company stocks. Build a portfolio of stocks that fulfills all your investment criteria.
• Be realistic: The company has to have a chance to succeed, but if it has a huge debt load and no cash, what chance does it have?
• Be patient: Invest in smaller companies with a ‘buyand-hold’ strategy.
Stocks of small companies are not for people who are averse to risk. But if you are willing to put a small part of your portfolio at risk for a potential payoff, consider them seriously. Invest systematically either through an SIP or daily STP to get a low average cost and make gains in the next boom instead of waiting for the next time the index touches 21,000.
— Harshad Patwardhan, Investment Manager, Equity, JP Morgan Asset Management