Price correction removes froth off smallcaps, should investors go on shopping spree?

For Dalal Street investors, 2021 was a stupendous year as crorepatis turned millionaires and the millionaires became billionaires.

The significant rally that stocks saw across the board in 2021, however, fizzled out in 2022 because deteriorating macroeconomic conditions globally and geopolitical risks raised questions over the frothy valuations of Indian equities, particularly that of smallcap stocks.

Thanks to the price correction seen over the last 1 year, it has put to rest concerns over valuations in this space for many market mavens.

In FY23, 547 smallcap stocks have given negative returns, and of this, 337 have corrected 20-90%.

“Now that earnings froth is not there in the segment and valuations have in fact gone down below long-term averages, small cap stocks are rebounding from their intermediate bottom,” said Anil Rego, fund manager and Founder, Right Horizons PMS.

Unless there is some unexpected slowdown on the consumption side, it’s safe to say with the rate hike cycle peaking in the near future, small cap stocks have seen most of the correction from the peak, he added.

At the index level, since January 2022, the S&P BSE Smallcap index has corrected more than 8%, whereas the benchmark Sensex has given around 2% positive returns.

Year to date, the smallcap index is down 3%, whereas Sensex is down about 1%.

“The P/E multiples of small and mid-caps are near their 5-year averages, and in some cases, the valuations are at levels seen during Covid sell off,” said Divam Sharma, Founder of Green Portfolio PMS.

Sharma expects stocks in the smallcap and midcap segments to see a re-rating of their multiples as interest rates start moving down in the coming quarters.

Meanwhile, the steep price correction that smallcap stocks saw did not perturb smallcase manager and smallcap bull Nikhil Gangil and moved him out of the space.

“We never left the space. Our 86% investments are in the smallcap space and they are up by 19% in the latest financial year, beating all the asset classes,” Gangil, founder of Intrinsic Value, said.

One of the main reasons for the outperformance of his portfolio was a sectoral rotation approach.

When IT, speciality chemicals and new-generation technology stocks faced the heavy selling, Gangil’s PMS stayed invested in auto ancillaries, banks, real estate, railway, infrastructure and some undervalued consumer players.

Gangil however, said that the smallcap stocks are now fairly valued and not undervalued after the steep correction.

Therefore, buying anything may not work, and one has to be selective here.

Gangil is waiting for a further correction in speciality chemicals and IT names to enter into them.

Meanwhile, Rego of Right Horizons is constructive on the building materials segment, while being selective in NBFCs and manufacturing themes from the small cap side.

Divam Sharma of Green Portfolio is betting on pharmaceutical, speciality chemicals, textile, and capital goods stocks in the smallcap segment. Some of the names that the PMS is invested in include Aarti Drugs, Valiant Organics, and SP Apparels.

The time-cum-price correction that smallcap stocks have seen does pave the way for the Dalal Street bulls, but they have to take the “slow and steady” approach to win the race.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)