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BW Businessworld

Stocks: Small Is Beautiful

Big is no more beautiful. It’s the new mantra for stock investing in 2016. Small is good; it can, and will, bring relatively bigger profits for disciplined investors.

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Big is no more beautiful. It’s the new mantra for stock investing in 2016. Small is good; it can, and will, bring relatively bigger profits for disciplined investors.

The domestic macros, including demographics and global economic trends accentuated by the decline in industrial commodity prices globally, point towards a major shift in business activity in India. As a result, hundreds of small- and mid-cap segment companies on the country’s bourses are expected to outperform the top fifty mega-cap companies comprising the leading indices by a wide margin. The outperformers are likely to draw heavily on the innovation, technology, management and agility.

Being big has its own problems. When the economy takes a sudden turn or some technological innovation disrupts the existing business models, large corporations are rather slow to adjust and adapt to such changes. This is precisely when a small startup comes with smart technology and takes the entire industry by storm. Rapid technology evolution has reduced the span of business cycle from earlier fifteen years to seven years now. Large size and a large debt pile make companies laggards when the market takes fancy to slim, asset-light and high return-on-investment companies.

In the calendar year 2015, to date, the mid-cap stock index is up by 10 per cent while the leading index Nifty is down by 3 per cent and Sensex by 4 per cent for the year. Given the sluggish outlook for other asset classes such as real estate and gold, household savings are likely to be channelised through mutual funds that are well positioned to take advantage of the rally in small- and mid-cap stocks. The domestic mutual funds nearly trebled investments, from $4 billion in equities in 2014 to almost $11 billion in 2015.

Conventional economic thinking that disregarded appropriate or optimum scale for a manufacturing activity and blindly embraced the notion ‘bigger is better’ is now being challenged in these times of market turmoil with repeated bouts of volatility in global equity, debt and commodity markets over the last couple of years.

The commodity prices, be it crude oil, metals or minerals, have been on a steep decline and are trading at a six-year low. The commodity index is down by about 70 per cent from the peak it recorded as the Chinese economy landed in lower growth trajectory. Double-digit growth in China during the last decade had pushed commodity prices through the roof. The dragon economy is likely to remain in low gear for the foreseeable near future and the commodity prices are likely to remain stable at the current levels without any major upward shock potential. The small- and medium-segment companies are able to take advantage of the fall in prices, as also the lower trend in domestic interest rates, which is quite visible.

In the backdrop of the global economic scenario, through combination of various government initiatives aimed at Make-in-India, the Indian economy is witnessing a significant structural transformation. This will ultimately lift the proverbial bottom-of-the-pyramid and catapult India into the world’s top five economies over the next few years. As opposed to ‘trickle down’ economics, India is now on the cusp of unleashing a nation of startups that are driven by technology and are agile.

Large size breeds complacency at times. Over the last five years, on the assumption of high single digit growth of about 8-9 per cent in the country’s gross domestic product, large corporations piled up large debt to expand capacities to service the increased demand. They even borrowed when the interest rates were still high.

Bank are now unwilling to lend further to large borrowers as about 80 per cent the non-performing assets (NPAs) are exposed to large scale companies. Real estate, diamonds, steel, mining, which are generally large scale borrowers, are put on the negative list by banks. Now, with commodities in slump and fall in interest rates, about 175 basis points over the year, small- and medium-segment companies are better positioned to take advantage and grow when high leverage pulls the large companies down.

With new government at the centre, fiscal prudence is taking precedence over populism. Policies are focused and favouring the medium- and small-segment companies. The policy shift is from ‘mass production to ‘production by masses’. It is highly unlikely to expect any kind of sops from the government on which the large corporations have thrived.

And last but not the least, is the liquidity. The foreign institutional investors are highly fixated with the frontliners. They have poured in billions of dollars in Indian equities over the years and are heavily invested in the top 50-60 large companies. When they decide to sell, there are hardly any comparable buyers who can absorb such selling pressure.

To summarise: the new year may not favour large companies that are unable to raise equity further, are highly leveraged already, suffer on account of lower commodity prices and slow to adapt to new technology. In contrast, small- and medium-segment companies are better positioned to take advantage of all these factors and return manifold to investors.

The old adage “when the going gets tough, the tough gets going” needs to be rephrased to “when the going gets tough, the swift gets going.”

The author is managing director of Sun Capital Advisory Services

(This story was published in BW | Businessworld Issue Dated 11-01-2016)

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

S.P. Jain

The author is managing director, Sun Capital Advisory Services

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