Meet the small-cap investors picking multibagger stocks

For India’s small but growing tribe of small-cap investors, the hunt for small-cap multi-baggers comes with the expectation of great rewards. “With small-caps, we will be able to get the highest return for the invested time, which we will never be able to generate by investing in large-cap companies even if we analyse them extensively,” says Sharma.

According toMintresearch, about 6% of listed small-cap stocks turned multi-baggers in the past 5 years – delivering 5 times or more returns in 5 years. However, investing in such companies is also highly risky. One in every seven stocks in the small-cap space on the National Stock Exchange (NSE) has either been suspended or delisted in the last 5 years, while only one in 16 turned into a multi-bagger (went up 5 times or more in the past 5 years).

Those who spend extra hours poring through company annual reports and stock exchange filings also need to ensure their stock picks outperform small-cap mutual funds, so as to justify their efforts. These mutual funds have delivered 2-3x returns over the past 5 years. As for ordinary investors, they can put money into a small-cap MFs and let the fund manager generate returns for them.

Filtering small cap stocks

Filtering and analysing a small-cap company from a myriad of more than 1,000 stocks is a tough task given the limited disclosures and information available in the public domain. Serious investors who directly invest in small-cap stocks often resort to the ‘scuttlebutt’ technique, which involves obtaining information from various sources including vendors, customers, and former employees, etc., to understand the business.

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Sharma is self-taught when it comes to investing. He learned the basics of investing from platforms like Varsity by Zerodha, online courses and by putting it into practice every day. For him, ValuePickr – a forum for discussions on Indian mid-and-small-cap companies, is the starting point to select a stock to analyse. “I take cues from those whose investing style I admire. But that’s just the starting point. I will do my own groundwork before buying a stock.”

Yashika Narang, a resident of Surat, was taught to save and invest by her parents in childhood. She started her investment journey with mutual funds but now has an exposure of almost 30% to small-cap stocks. Narang approaches small cap investing systematically. “I follow a top-down approach and focus on finding the industries that have tailwinds. Then I look for companies that are potential beneficiaries in the value chain; I map the full value chain of the industry starting from the manufacturer of the product, distributors, customers, to the middle-men who are marketing the product,” she said.

According to Mumbai-based finance content creator Aryan Mulchandani, 21, when it comes to screening small cap companies, “I first filter out stocks that have a price-to-earnings ratio of more than 50. This is just a quick way to remove operator-manipulated stocks or those that could have garnered a lot of interest in the last 6-12 months.”

Mulchandani, who is also a member of Multipie, a social network for investors, follows a contrarian style of investing where he looks for companies that are facing headwinds but are in a turnaround phase. He believes that the right small-cap stock is not correlated with the market and acts as a different asset class.

Narang backs up her initial filters with some more checks. “I look at financial ratios such as profitability, asset turnover and leverage. If I think that a company can balance three of these levers and expand ROE (return on equity), I will consider investing in it,” she added.

How much time to devote

A few of the direct small-cap investors thatMintspoke to said that they spend a minimum of 20-25 hours researching a small cap stock before they invest. This process can sometimes stretch to a few months. Investing in small-cap stocks is not just about earning supernormal returns for many young investors; it is also about passion, zeal for learning and the thrill of finding a multi-bagger.

For Ankit Gupta, 35, an engineering graduate from Ahmedabad in Gujarat, it was an extremely difficult decision to resign from his job in 2018 to become a full-time investor.Gupta,who is now a CFA (Chartered Financial Analyst) charter holdernow believes that small-cap investing is not very risky, provided investments are backed by thorough research. “I significantly invest in companies with a market capitalisation of less than ₹10,000 crore. I study the company for about three to four weeks and go through their past 10-12 years of annual reports,” he said.