Small caps stocks can provide good returns in long term
20 June 2016
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According to a Morgan Stanley study, 85% of micro- and nano-cap stocks delivered better returns than the market

Betting on quality micro-cap stocks may fetch you superior returns, if you have the patience to hold those for a long term. Nearly 85 per cent of micro and nano-cap stocks, having less than Rs 265 crore market capitalisation, delivered better returns than the overall market’s returns in the past 10 years, according to Morgan Stanley.

The Wall Street firm studied the returns on 1,613 stocks traded during March 2002 and March 2012 in India and found wealth creation was best in micro-cap stocks. Companies de-listed or merged with other companies during the past decade were excluded from the analysis.
The median 10-year return for 1,613 stocks was 18.4 per cent compounded annual growth rate (CAGR), while the average price return for the sample was 18.7 per cent CAGR, Morgan Stanley found in its analysis. The median return from equities exceeded the 10-year government bond yield or the risk-free rate, which was 7.5 per cent in March 2002, by almost 11 percentage points. In comparison, average return for stocks having a market cap less than Rs 265 crore was 23 per cent CAGR.
Interestingly, the average return from the top 20 stocks in 2002 is 13 per cent CAGR, worse than the market median. Not just that, 11 of these stocks underperformed the market.

The lesson from history is to back companies that improve on their return on equity (RoE) and judiciously accumulate capital, according to the firm. Also, growth alone is not enough; valuations too, matter. On an average, stocks with rich valuation in 2002 failed to deliver superior returns in the 10-year time frame and vice versa.