Buying And Selling Strategies

Should a Small Investor Always Stick to Small Cap Stocks?


“If buying small and micro caps is the way to riches it is also the path to bankruptcy” -Basant Maheshwari 


This section begins by explaining why it is not a good idea for investors to focus solely on small caps. The pitfalls of small cap investing, survivorship bias issues, and when it makes sense to focus solely on small caps versus when it makes sense to stick with tried and tested large caps.


 Small cap companies with no entry barriers are unsuitable because they lack the ability to grow into large cap companies. 


A company must have revenues of at least ₹100 crore to demonstrate that their business model is viable. Small caps have a very slim chance of surviving a pandemic. 


You must determine whether the small cap company has the ability to scale its operations or not.


Multibaggers from Small and Midcap stocks


Small cap companies are the ones which could lead you to early retirement but such companies also have potential to put you back to work from retirement.


This section elaborates on the various filters that should be used when purchasing potential multibaggers from the small and mid cap space. 


These filters include business, sector positioning, management, growth, industry tailwinds, and financial analysis of these potential winners. The trigger for multibaggers will be the company's growth and scalability, not the valuation at which it is available. 


For example, when a company continues to take market share away from the organised sector. VIP Industries or Safari may fall into this category. 


Small cap companies that are not leaders in their industry run the risk of slipping in terms of earnings delivery and execution. However, if the sector is very large, one may not need a leader. SUN TV vs. ZEE, for example. 


The combination of no equity dilution, less/no debt, and increased revenue through operating leverage is a sure-fire multibagger. 


One must determine whether the management is competent because - Small cap companies frequently lack the resources to hire professional managers. A promoter whose motivation is not management compensation but rather the performance of the company would be the best. For example - Ambika Cotton Mills. 


Profitability may suffer temporarily as a result of advertising or capital expenditures should not be given much weight. 


The author’s checklist includes the following items:


  • ROE > 30%
  • No dilution of equity and less/no debt
  • Debt should be less than 50% of the net worth
  • Positive cash flow
  • Dividend yield is 1.5 to 2%

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