Hi All,
Got a nice What's App forward on selecting a small Cap Company.... worth reading
Buying Strategy for Small Caps
1. Go for companies with
low debt ratio (preferably less than one)
2. A high interest coverage ratio
(above 3x) and a high return on equity are big advantages
3. Avoid companies
with huge liabilities in the form of foreign currency convertible bonds /
external commercial borrowings
4. Look at the quality of the management, its
governance standards and how investor-friendly the company is.
5. Mid-cap and
small-cap companies can be future market leaders, so be patient with your investments
Those
who wish to invest in small-cap stocks should do so only if they have a long
investment horizon and tolerance for volatility. Small-cap stocks suffer the
steepest falls in a bear market and rise the most in a bull market. An investor
should stay invested for at least three-five years to allow their portfolio to
gain from at least one bull run.
Benefits of Investing in Small Caps
1. Huge
growth potential: The first and the most important advantage that a small
cap stock gives you is their high growth potential. Since these are small
companies they have great scope to rise as opposed to already large
companies.
2. Low Valuations: Usually small cap
stocks are available at lower valuations compared to mid & large
caps. Hence, if you invest in good small cap companies at initial stage
and wait for couple of years, you will see price appreciation
not only because of growth in top line and bottom line but also due
to rerating which happens with increase in market capital of the
company.
3. Early Entrance Advantage: Most of the fund house and
institutions do not own small caps with low market cap due
to less liquidity which make it difficult for them
to own sufficient no. of shares. This gives retail investors an
opportunity to be an early entrant to accumulate such companies
shares. When company grows in market cap by delivering consistent
growth and becomes more liquid, entry of fund houses and
institutions push the share prices up
giving maximum gains to early entrants.
4.
Under–Researched: Small cap stocks are often given the least attention by
the analysts who are more interested in the large companies. Hence, they are
often under - recognized and could be under-priced thus giving the investor the
opportunity to benefit from these low prices.
5. Emerging Sectors: In a
developing economy where there are several new business models and sectors
emerging, the opportunity to pick new leaders can be hugely beneficial. Also
the disruptive models in the new age is leading to more churn and faster growth
amongst the nimble footed smaller companies.
Concerns while Investing
in Small Caps
1. Risk: The first and the most important disadvantage a
small cap stock is the high level of risk it exposes an investor to. If a small
cap company has the potential to rise quickly, it even has the potential to
fall. Owing to its small size, it may not be able to sustain itself thereby
leading the investor into great loses. After all, the bigger the company, the
harder it is for it to fall.
2. Volatility: Small cap stocks are also more volatile
as compared to large cap stocks. This is mainly because they have limited
reserves against hard times. Also, it in the event of an economic crisis or any
change in the company administration could lead to investors dis-investing
thereby leading to a fall in prices.
3. Liquidity: Since investing in small
cap stocks is mainly a decision depending upon one’s ability to undertake risk,
a small cap stock can often become illiquid. Hence, one should not depend upon
them for an important life goal.
4. Lack of information: As opposed to a
large cap company, the analysts do not spend enough time studying the small cap
companies. Hence, there isn’t enough information available to the investor so
that he can study the company and decide about it future prospects.
Cheers Hrishi
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