Smallcap Hunters: Stock-picking strategies beyond usual metrics

By Arun Mukherjee & Soumya Malani

(Kolkata’s Arun Mukherjee, who dropped out of college to turn a full-time investor at an early age, and Soumya Malani, a London School of Economics passout, have come to be known as smallcap aficionados within India’s investor community. They would show up at most AGMs, visit the remotest factories of a company and go chasing end-users to understand their experience with a product in their passionate hunt for good smallcaps. Arun and Soumya would be sharing their experiences with such companies from the ground in this space every now and then. Keep watching...)

Conventional metrics for stock picking such visionary promoters, scalable business and rich valuation ratios are important, but when it comes to smallcaps and microcaps, some fundamental patterns can help bring a company on your radar much earlier. That has been our experience with smallcap hunting in last one decade.

In this space, we would try to throw some light on what these fundamental patterns are and how they work.


1. Negative working capital patterns: When a business operates on other people's money (OPM) or suppliers’ money, advances from customers is a good hint to go by.

2. Leaders in a niche area with tiny market-caps: Once such businesses grow and the market realises their potential, you get huge multibaggers. This reminds us of the domestic consumption stories. Look back at the market-cap of a Cera or a Symphony or a La Opala. They were minuscule compared with the scale they catered to. They had their supply chains and distribution networks in place. Tailwinds followed and the market took them into a different orbit.

3. Promoter changes: Take the recent example of Uniply or Kingfa. Both the companies have been over 30-baggers in last 3-4 years. Kingfa was again a common-sense choice. A Chinese giant, which grew from nothing to be the Asia’s largest compounder, had a track record of 65 per cent CAGR for 22 long years. It saw its market getting saturated in China and acquired an Indian company at three times premium to prevailing price. They took control of the Indian business, brought in efficiency and the stock became a huge multibagger.

4. Eradication of non-core di-worse-ification: Some companies would have solid profitable core businesses, but owing to loss-making non-core units, the overall balance sheets and profit & loss accounts would be in a hodgepodge shape. Sometimes, sanity would prevail and such a company would sell those units and plough back the fund into core business, further accelerating growth. The market loves such stories.

5. Companies that outperform during huge headwinds: TV Today is a classic example. Barring the Aaj Tak parent, every single company was bleeding badly in the media sector. The digitisation became a gamechanger, with the stock becoming a 12-bagger in last 4-5 years.

6. Demerger in a sizeable company: FIIs have got market-cap stipulation and, hence, they tend to sell out in haste, which sometimes leads to artificial fall in stock price, taking it even below intrinsic value. Arvind Infra and Marico Kaya are examples of huge value creation.

7. Companies eating market shares of market leaders: Amara Raja, Havells are good examples, as they took market shares from market leaders Exide and Crompton Greaves.

8. Second-run companies in sectors where leaders have been multibaggers: At times, valuation gets so stretched that investors begin to look for smaller peers and the valuation gap narrows. Avanti-Waterbase, Relaxo-Mirza, KRBL-Chaman Lal are good examples.

9. Strong Leverage but very efficient in working capital management: At times, capex would be covered for 3-4 years. Just the maintenance Capex remains. So, all operating cash flow goes into debt repayment and net profit vaults.

10. Legacy companies seeing induction of new generation: The predecessors were habituated to siphoning off, a.k.a. black money, but the new guys – who in most cases would be freshly groomed from renowned business schools –would be inclined to look at market-caps, which is pure white stuff. It’s a simple math. A small-cap promoter may siphon off Rs 5 crore through unscrupulous means. But how about showing the same through books of accounts? The same Rs 5 crore would mean an extra Rs 100 crore in market-cap, considering a PE of 20. On even a 50 per cent ownership, they can get richer by Rs 50 crore. Which is better? This area offers serious money-making opportunities now. Moves like demonetisation has helped more such cases to emerge.

(Views and recommendations given in this section are the analysts’ own and do not represent those of ETMarkets.com. Please consult your financial adviser before taking any position in the stock/s mentioned.)