In an interaction with Pawan Bharaddia, Co-Founder and CIO, Equitree Capital
The amount of due diligence that needs to be done before investing in this space is significantly higher than that in larger mid-cap and large-cap companies, asserts Pawan Bharaddia, Co-Founder and CIO, Equitree Capital
What are the key risks facing equity markets at this point in time?
Markets will always have some or other risks. We have been recently plagued with issues like unprecedented inflation globally, fear of rapidly rising interest rates potentially invoking slowdown/recession in global markets, geopolitical issues like the Russia-Ukraine war, depreciating currency, and so on & so forth. While some of these issues will continue to keep the markets volatile in the short run; however, we aren’t seeing any panic in the markets. Firstly, Indian investors have risen to the occasion and have provided abundant liquidity to the markets absorbing almost the entire FII selling that we saw over the last nine months. Secondly, India has emerged as one of the most stable and resilient economies amidst all the global chaos. With opportunities to double up its global merchandise exports as well as the continued buoyant domestic market, India is poised as one of the fastest-growing economies and should continue to attract global investors as the noise settles.
Having said that, given the uncertainties in the global environment, it may not be best to take a generalist view of the market. We strongly believe that in the current time, one needs to do a ground-up analysis of business and look for reasonable valuations to identify investment opportunities.
What is your outlook on auto Small-Cap stocks?
We identified an opportunity in the auto and auto ancillary space in May 2022. This was back when the industry was beaten down, demand revival was on the brink and not many people were looking at the sector. Since then, Nifty Auto index has risen approximately 22 per cent to reach an all-time high of 12,660.
The auto sector seems to be coming off its long-drawn issues. On the PV front, demand is strong but there were some supply side issues (like the semiconductor & raw material issues), which are now easing out. The CV cycle has begun to see a resurgence and is doing well too. Over the last couple of months, quite a few large auto & auto ancillary companies have seen a decent run up with some of them going up as much as 40-60 per cent too. We believe this run-up now factors in expected growth in some of these businesses and may not leave much room for further upside.
However, this run-up has not percolated down as much to the small-cap auto stocks. There are quite a few interesting companies in that space still trading at reasonable valuations. We particularly prefer companies that are market leaders in their respective products and are working on import substitution products or products that are export-oriented.
Why is it considered risky to invest in small-cap and micro-cap stocks?
The small and micro-cap space is one of the most attractive spaces to create long-term wealth and still, the majority of investors end up losing money in this genre of investing. This is broadly due to the lack of information available on these companies. The amount of due diligence that needs to be done before investing in this space is significantly higher than that in larger Mid-Cap and Large-Cap companies.
The companies, their promoters, and their business models are still to be tested. In this context, the probability of betting on a sub-par company is quite high, given the amount of ‘tips’ and ‘picks’ that circulate in the market. Investing in this space requires thorough research, channel checks, financial analysis, and constant tracking. Out of over 3,500 small and micro-cap companies, only 10 per cent have given multibagger returns. However, the risk-reward in this segment is substantial; when you do get the company right, you can generate supernormal returns.