A rate of return of this magnitude (50-100 per cent) in just 30 trading sessions in any other asset class will not be possible, except for in equities. But any investment in smallcap stocks comes with added risk.
LT Foods more than doubled investor wealth so far in 2017, while shares of Arshiya, National Fertilizers, Unitech, Jaiprakash Associates, Monnet Ispat, JP Power Ventures, Lumax Prakash Industries, Future Enterprises rose over 50 per cent each in the same period.
The BSE Smallcap Index has, in fact, been outperforming since 2016. In the last one year, the BSE Smallcap index has generated 28 per cent return in contrast to 17 per cent rise in the BSE Sensex.
The S&P BSE Smallcap index comprises of 778 companies and is representative of each and every sector listed in the stock market.
The rally in the smallcap stocks should continue for some more time given the increased government focus on rural sector and infrastructure spending, but the risk to the reward-ratio has reduced considerably.
The benchmark equity indices have given a return of 7 per cent so far in the year 2017 whereas BSE Smallcap index has risen 11 per cent, which is almost 60 per cent more return compared with the benchmark index.
The risk of a sharper correction is more prominent for the smallcaps when these flows start reversing. Hence, investors will be better off taking exposure in quality smallcap stocks. A bottom-up approach will be a good strategy for investors who want to stay in the market.
Valuations paint a different picture
With respect to valuations, the BSE Smallcap Index is trading at 69.60 PE in contrast with 22 times PE of BSE Sensex and that means the smallcap stocks are trading at a huge premium to largecap stocks represented by the broader market index i.e. Sensex.
However, while choosing a smallcap stock, investors should focus on fundamentals and the other parameters such as valuation, which should give a good margin of safety to investors.