Personal Finance

Why small-caps aren’t big bets

Keerthi Sanagasetti BL Research Bureau | Updated on April 03, 2021

12% chance of one becoming big in 10 years; 55% don’t beat Sensex’s 9.8% CAGR

Rookie and so called high-risk investors often buy small-cap stocks, betting on their potential to become tomorrow’s large caps. But there is only a small possibility of this happening, going by their performance in the last decade. A check of the top 250 small-cap stocks by market capitalisation as on March 31, 2011 shows that in the last ten years, only three have moved to the large-cap bucket.

That is, barely a 1 per cent chance! Not just that, many small-caps also lost the battle in terms of alpha generation — the very reason that one invests in these stocks. The returns (CAGR) generated by half the small-cap companies could not beat the Sensex’s 10 per cent returns (CAGR) in the last ten years.

No giant leap

AMFI (Association of Mutual Funds in India) classifies stocks based on their market capitalisation — the top 100 being large cap, the next 150 mid-cap and the remaining, small-cap. We used the same criteria to classify the stocks as of March 2011 and March 2021. Given that there is a long tail, we have restricted our analysis to the top 250 stocks in the small-cap bucket.

Going by this, only three companies out the top 250 — Bajaj Finance, Cholamandalam Investment and Finance and Honeywell Automation India — grew to enter the league of top 100 companies (large-cap) over the last ten years. And only 27 of them inched up to the mid-cap category. Prominent names among these include MRF, Mindtree, PI Industries, Page Industries and Balakrishna Industries.

In all, there is just a 12 per cent probability of a small-cap stock moving buckets in a fairly long timeframe of 10 years. Eight stocks from our sample set are no longer listed leaving 212 to remain small-cap ten years since.

Elusive Alpha

While the bellwether index Sensex grew at a compounded average growth rate (CAGR) of 9.8 per cent from FY11 to FY21, 55 per cent of the small-caps, that is about 137 stocks, could not even beat this return, over the same period. Worse, 78 small-cap companies became smaller, eroding shareholder wealth.

The infrastructure theme that dominated the 2007 bull market, for instance, has now largely gone bust. The list of wealth destroyers comprises many infrastructure players — Punj Lloyd, IL&FS Engineering, Simplex Infra and Uttam Galva Steels. Others such as Karuturi Global, Gammon Infra, and SREI Infrastructure Finance are now penny stocks.

Those who delivered

Yet, the investment thesis, ‘Catch them young and watch them grow’, widely used for backing one’s investments in the risky small-cap stocks, could not be entirely negated.

There is a good 42 per cent chance of small-cap companies generating better-than-market returns. That is, about 105 small-cap companies generated returns (CAGR) of over 10 per cent, in the last 10 years. The top performer was Bajaj Finance that grew at a CAGR of 62 per cent. Next came PI Industries and Balakrishna Industries that gave returns (CAGR) of 48.5 per cent and 38.1 per cent, respectively, from FY11 to FY21. Other prominent mid-cap bets of today such as JK Cements, Abbott India, SRF, Coforge and Sundram Fasteners were all small-caps in FY11.

 

Published on April 03, 2021

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