Smallcap stocks: How to play the smallcap opportunity?


Vinit Sambre, Head of Equities at DSP Mutual Fund, says it requires a lot of patience and temperament to bet on midcaps and smallcaps, and this is something an average investor lacks.

You track the smallcap space with a magnifying glass. Where within that, are you sensing opportunities?

First of all, on the price point front few segments have actually gone past their reasonable valuation zones. But there are a few categories which I would say are still relatively fairly valued, or reasonably well valued. These are the segments, let us say in building materials as a category, where the momentum has not picked up because of the overall slowdown. Then there are sectors within the textile industry, the home textile players, and even some of the branded garment players which are going through bit of a tough phase.

As we speak, the home textile players are witnessing some bit of positive momentum. So I would say, these are the relatively cheaper valuation spaces. While the business momentum seems to be improving in some of them, some other will take longer. Hence, I would say it is the time spent in the market which is going to determine how much returns one will be able to generate by investing in these categories. Definitely they are cheaper for a reason. The visibility is poor right now, and once the visibility improves, these are the trades which should eventually turn out to be winners in the future.

You touched upon financials and how they are kind of lagging. What is the outlook on that front?

I think we all are aware the financial sector is going through a bit of testing times. While some of them have been able to manage the affairs slightly better if we look at the moratorium numbers, and some of the other aspects. But I would say it is going to be a tough phase for lending businesses across. At the same time, for banks that have a very good track record of maintaining high asset quality over a long period of time, the current distress may become an opportunity to capture market share. So banking has to be look at from that lens. The challenging phase is going to be there for a year or so, and beyond that players that are going to look good are the ones which have had very strong or good asset quality historically and have been capturing market shares.

As is generally known, if the economy has to grow, the banking sector has to support that. So I would say be selective, be cautious within the banking space. We have reduced our exposure to the lending businesses overall, but at the same time we are focused on the banks that we believe would eventually gain and turn out to be better investments in the long run.

What would a realistic return expectation, let us say, from the midcap or smallcap funds going forward? Do you feel this market move we have started to see is sustainable?

I would say midcap and smallcap investment, particularly, and equity investment broadly needs a lot of patience and temperament, which I feel an average investor lacks. That is where the mismatch occurs between expectations and finally what the returns are. As I started by saying, in the midcap and smallcap spaces, we have seen companies remain in slumber for three, four, five years. And in a matter of four-five months, they can deliver the returns of the whole four-five years. We saw that happening across few names in our portfolio in last one or two months. So I would say that these investments have the potential to deliver good outperformance over largecaps over a longer period of time, the only caveat being that investors need to exercise lot of patience and this I would say is true of the equity investment. It is not a one month-two month story, these are businesses which take time to grow.

Many companies as they start growing will get success and they will keep on growing bigger and bigger which would then start getting reflected in terms of not only higher EPS, but also PE rerating. The maximum compounding happens towards the latter stage. So I would say buying into equities during a tough phase like now while the valuations may look slightly on the higher side, but over a longer term, these would definitely get ironed out. We would see returns in sync with how the earnings pan out eventually, and what ROEs and ROCs these companies manage to deliver. So that is where the investor should look at in terms of the anchor, as to how the returns are going to look like in these categories.

Is it a good time to revisit autos, because they had a poor 2019 and a terrible 2020?

We have enhanced our exposure to auto within the consumer discretionary basket, and the pure reason is that they have gone through two years’ of pain phase. If we look at the auto numbers now, actually the whole sector has gone a decade backward in terms of the numbers. So I think it is a pretty good low base, which has got created. Number two, the need for personal mobility is definitely going to drive much larger consumption as far as the auto is concerned. Also, the rural part of the country is still relatively better and is supporting the growth in momentum. So I would say all these factors are probably in favour of auto. While not calling out for an immediate turnaround, I would say with a good base and all the factors placed in their favour, I would like to see the auto sector do well over the next two to three years

We have seen a fantastic move coming in across most of those pharma names. How bullish are you on this trend in pharma and healthcare as a whole?

While a large part of the optimism has really got captured in terms of the price points, so to anticipate similar or even a decent upside from here on is not something I am going to predict. What I can is that the sectoral dynamics are looking relatively much better versus what they were, let us say, two years or three years back. A lot of positive changes have taken place both in terms of abatement of the generic price pressure in the US market, and the growth momentum in India generally from the lows we had seen in last two to three years. Thirdly, because of the Covid crisis and the China factor, there is a lot of interest in the API manufacturers. So I think that is an additional factor which is leading to some of the API guys doing well. It looks like India seems to be a relatively preferred destination when it comes to the pharma space, because not only do we have the chemistry skills, but we are one of the lowest cost producers of drugs globally.

As most countries embark on the journey to reduce healthcare cost, generics are something which is going to be preferred. I would say healthcare as a category is more of a non-discretionary play. If there is a need to consume healthcare, one has to go for it. So the sectoral dynamics looks pretty okay.

The return expectation has to be a bit tempered, but at the same time, within the broader healthcare category, I would say the service providers — which mean hospitals, laboratory business — faced quite a bit of a pressure in the last quarter. For them the outlook is likely to change for better over the next six, seven months, as we expect many patients who had postponed their elective surgeries to come back. They would see better occupancy and the healthcare service providers should do well going forward.





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