Small-cap vs Large-cap – Separating Facts from Myth
Author : Aequitas
The markets are driven by a number of beliefs and sentiments, which, on close examination turn out to be long-perpetrated myths. Aequitas – an investment firm known for delivering outsized returns on small-caps – calls the bluff on some and presents the facts for a balanced perspective on small-caps.
Myth 1: Large-caps aren’t risky
Large-caps are not immune to risk. Suzlon Energy, Reliance Communications and Unitech have shown that large-caps can be affected by massive drawdowns. Besides, being well-established, the growth potential of large-caps is lower than that of mid- and small-cap companies.
Myth 2: Small-caps are as good as penny stocks
Many large firms such as Avanti Feeds, Eicher Motors and Finolex Cables started as small companies. However, due diligence is a prerequisite to small-cap investing. Our first criterion is that the company should be an industry leader or sole provider in its area of operation. Retail investors must avoid small-cap stocks with annual revenue of less than Rs 500 crore. Profitability and operating margins should be the key indicators. The valuations must be reasonable and the margins sustainable. Avoid companies with low promoter holding. Debt, capacity, P/E, net cash and EBITDA margins are other crucial factors to be taken into consideration.
Myth 3: Inclusion in the NIFTY is an indicator of stock quality
Market Capitalisation is not relevant, profitability is. Between 2009 and 2018, small-caps outperform large-caps through upcycles, growing by a factor of 7, as opposed to a factor of 4 for the latter. Investors need to see the long-term picture and ignore short-term volatilities.
SUMMING UP
Outsized wealth can only be generated through a contrarian approach. Such an approach does not mean doing the opposite of what others do; rather, doing things differently. Popular stocks can never provide multi-bagger returns. High-growth companies in out-of-favour industries that are significantly undervalued hold great promise if you seek multibagger returns on your investment.
Aequitas Investment Consultancy Pvt. Ltd. is a boutique investment firm that specialises in small-caps. Our clients comprise over a hundred UHNIs, family offices and FPIs. As of May’24, with an AUM of more than $500 million, our PMS CAGR of 34% has significantly outperformed the NIFTY all along.
To know more about our potential multibagger offerings, visit us at www.aequitasindia.in or write to info@aequitasindia.in.
Frequently Asked Questions
1. Are large-cap stocks less risky than small-cap stocks?
Large-cap stocks can still experience significant price declines. Their established position does not eliminate market, business, or valuation risks.
2. Are small-cap stocks the same as penny stocks?
No. Small-cap stocks represent companies with relatively smaller market capitalisation, while penny stocks generally refer to very low-priced, often highly speculative stocks.
3. What should investors consider before investing in small-cap stocks?
Investors can consider factors such as revenue, profitability, operating margins, debt levels, promoter holding, valuation, and the company’s competitive position, among other parameters.
4. Does NIFTY inclusion guarantee stock quality?
No. Index inclusion reflects eligibility based on defined index criteria and does not by itself guarantee a company’s profitability, business quality, or future performance.
5. Why do investors compare small-cap and large-cap stocks?
Comparing small-cap and large-cap stocks can help investors understand differences in company size, growth potential, volatility, valuation, and risk, and alignment with their portfolio strategy.
