Whenever small caps trade at a discount to Nifty, they have given outsized returns: InCred Wealth

• This year, mid and small caps have underperformed as compared to the benchmark indices.
• Currently, the Nifty small cap PE ratio is at 0.7 times Nifty50, shares InCred Wealth.
• InCred Wealth believes that the small cap market segments are relatively under researched, and offer a significant valuation cushion currently.

In 2022, small cap stocks have corrected and this fall is an opportunity for investors to build their small cap portfolio, Yogesh Kalwani, head of investments at InCred Wealth said on Tuesday.

Currently, the Nifty small cap PE ratio is at 0.7 times Nifty50. As per InCred Wealth, whenever small caps PE traded at 0.7 times that of Nifty50 or lesser, they have given relative outsized returns over the next one, three and five year holding periods.

“Historically this number was about two times, which means they always mostly traded at a premium, there were patches in which they traded at a discount to Nifty50. So on a relative basis it is reasonably valued, it is attractively placed,” said Kalwani.

For investors with enough cash to invest, InCred Wealth suggests buying equities in a staggered way from a mid-long term perspective. They however have to be aware that markets will remain turbulent in the immediate future. However, over the investment horizon of more than two years, equity will deliver double digit returns, the investment firm says.

InCred Wealth suggests one can also choose portfolios that have a mid/small cap bias and that are carefully curated by active portfolio managers.

“Going forward in one year or so you will see a lot more outperformance which can be generated by stock selection, sector themes and midcaps and small caps. Why so because the rally in Nifty50 probably in the last one week has been quite narrow. The broader market has not participated in this uptrend so that’s something which as a segment of the market will probably look up and give positive returns and there is an alpha which can be generated from this segment,” Kalwani said in a session on small cap stocks.

Small cap stocks are relatively more volatile than large caps as they are typically young companies with more risk, but tend to offer huge growth opportunities.

So far this year, mid cap and small caps have under performed the benchmark indices Sensex and Nifty50.

Look beyond Nifty50

InCred Wealth believes investors need to look beyond the benchmark indices which will offer limited returns in the near term. “Nifty offers limited near-term upside from here as the outcome will be a function of pushes and pulls of global and local macro, and improved margin of safety (P/E de-rating or stronger growth),” said Kalwani.

Moreover, the investment company sees earnings growth to moderate in the next few quarters because of persisting inflation, high input costs eventually impacting corporate earnings.

“While inflation could have peaked, impact on growth will be felt over the next few quarters. Earnings outlook in the immediate term looks uncertain. Higher input costs will act as headwind for corporate margins. Inflation persistence (though peaked) may cause demand slowdown. We expect moderation in earnings growth for Nifty Index over next 1-2 quarters,” said Kalwani.

Some of today's large caps which were small caps at one point in time
Source: InCred Wealth

InCred Wealth believes that the small cap market segments are relatively under researched, have a larger universe to choose from and offer a significant valuation cushion currently.

Small caps make up for the majority of the Indian listed companies. The first 100 companies are large cap on the stock exchanges, between 101-250 are mid-cap, and companies listed from 251 and below are small cap companies.

InCred Wealth manages over $1.5 billion or ₹10,500 crore of AUM with 1,900 high net worth (HNIs), ultra HNI clients and over 80 relationship managers across nine cities in two years of its inception.

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