There’s no more important question facing investors than how to find great stocks. Just one stock can make a difference of tens or even hundreds of thousands of rupees, but finding tomorrow’s big winners isn’t easy. Not even top 5 Online Stock Market Courses in India could guarantee that!
Investing in small-cap stocks is a good start if you’re looking for multi-bagger returns. These are smaller companies than the blue-chip stocks but tend to offer the most growth potential. That makes small caps among the most exciting segments in the stock market today. The question is how to find small cap stocks in India.
What are small cap stocks?
Small-cap stocks are usually people’s popular investment choice. To seek higher returns, people mindlessly buy small company stocks with a market capitalization generally ranging between ₹500 crores and ₹5,000 crores. According to AMFI, 251 companies in market capitalization are called small caps. But before looking at how to find small cap stocks in India, let’s understand the benefits of investing into small caps.
Features of Small Cap stocks
- Less Liquidity: Small-cap stocks have smaller equity capital. Assume that Rs 100 crore must be invested in stocks. If we invest in small-cap stocks, we’ll face difficulties because of lower liquidity. After all, their availability is smaller. There is a chance they would rise by maybe three or four times and more than invested Rs 100 crore in large companies. This increase would be because large companies are available in large quantities, due to which they can absorb such kinds of flows. So, for small companies, when a lot of money starts chasing them, it isn’t easy for them. If invested into any wrong company from stock market free webinar, there is risk of heavy loss.
- Highly Volatile: Investment risk in the stock market is closely related to volatility. If the stock price remains stable even in turbulent markets, the stock has low volatility. On the other hand, if the stocks witness significant price fluctuations at such times, they are termed highly volatile. The stocks of large-cap companies tend to be less volatile, which means their prices remain relatively stable even amid turbulence. This stable nature makes large caps relatively low-risk investment options. Mid-cap stocks are slightly more volatile than large-cap stocks and carry more risk. Small-cap companies are highly volatile, and their prices can swing considerably, increasing investors’ risk.
This high risk even as per stock market free webinar, because small-cap stocks are more influenced by market sentiment, news, and rumors. Positive or negative news related to them would lead to exaggerated price movements.
- High Growth Potential: Small-cap companies often have significant growth potential because they are in their early stages of development. They might operate in niche markets or have innovative products/services that can lead to rapid expansion provided their financial sheets ae strong.
- Less Established: Small-cap companies are generally less established compared to larger corporations. They might have shorter track records and less proven business models. They might depend more on a few key individuals, such as the founder or CEO.
- Limited Analyst Coverage: Small-cap stocks may receive less attention from analysts and financial institutions than larger companies. Investors pick up quality stocks at a low valuation and invest in them. In such scenarios, these investors have an advantage over institutional investors who ignore these small caps. With time, small-cap stocks gain recognition and acquire capital due to a higher organic growth rate than large-cap stocks. When seasoned investors put their interests in these stocks, pushing the share prices, you will earn optimum returns on stocks bought at fair prices.
Who Should Invest in small-cap Stocks?
As per best stock market courses,small caps area good investment asset for the following group of people:
- Investors having higher risk bearing capacity,
- Investors wanting high yield, more than what large caps can offer,
- Investors who can be patient to stay invested for a long-term for about a decade.
Now the main question, how to find small cap stocks in India?
Picking small-cap stocks in India requires a systematic approach, thorough research, and an understanding of the unique characteristics of these stocks. Here’s a step-by-step guide for how to find small cap stocks in India.
- Separate wheat from the chaff: Filter the stocks
The first thing you need to do while looking for great small caps is to start with small companies. For our purposes, small companies mean any company with a market capitalization (market cap) between 500 Cr and 5000 Cr. As per best stock market courses in Delhi, here are a few filters for how to find small cap stocks in India:
Also, the stock must have an ROE and ROCE of at least more than 15%.
We also need to see that the sales and the profit growth for the last five years is more than 15%.
The debt-to-equity ratio of the company should be less than one time. These companies are small and need capital to expand, so we have taken a high debt-to-equity ratio. But if you are uncomfortable with the ratio of 1, alter it to the usual of 0.5 times.
According to Screener, 837 companies are trading between 500 Cr and 5000 Cr.
After adding all these additional criteria, we are left with just 96 Companies. So, our universe has become smaller.
You can find the screener link in the description- https://www.screener.in/screens/1120127/good-small-cap-stocks/
- Check for industry growth
One must invest in small companies that serve large, burgeoning markets. These small caps can realize tremendous growth with even a small market share. The sheer size of the markets creates the potential for huge gains while helping to reduce your risk profile as per best stock market courses:
For example- From the given list one of the stocks is Globus Spirits belonging to the Spirits Industry.
- The Indian spirits industry is destined to grow because of the country’s sizeable middle-class population with increased purchasing power, rapid urbanization, changing consumer preferences, and a reduction in cultural barriers to drinking. The country’s population is around 1.3 billion, and the strong demographic profile that the youngest population makeup in the world, with ~50% of its population below the age of 25 and 65% of the population below the age of 35 the per capita alcohol consumption in India is set to boom.
- The domestic market is projected to cross 1200 Mn cases in volume by 2025. Positive demographic factors, including more than 10 million people added yearly to the population eligible for drinking, make it one of the most attractive markets for alcoholic beverages.
This data was taken from the annual report of Global Spirits from the MDA section. This makes globus spirits very interesting for us. As the company belongs to sector having huge potential in the future and the company having strong financials, this is a company worth reading.
- Check for MOATs in the business
Identifying a competitive moat in small-cap stocks involves looking for factors that give a company a sustainable, competitive advantage, making it difficult for competitors to erode its market position, dominance, and profitability. This is an unfair advantage for such companies as per best stock market courses in Delhi.
- Cost Advantage: Companies that have a cost advantage over their competitors due to efficient operations, economies of scale, or access to unique resources can maintain higher profitability and fend off competition.
- Regulatory Moat: Companies operating in regulated industries might have a moat due to the high barriers newcomers face when complying with regulations. E.g., Paushak
- Market Leadership: Being a dominant player in a niche market or specific geographic region can provide a moat by making it challenging for competitors to gain a foothold.
- Proprietary Technology or Intellectual Property Moat: Companies with unique technology or intellectual property that is difficult for others to replicate can have a strong moat.
Basically, small companies should have an economic moat and some niche products, or services in their offering.
Take the example of Rajratan Wires. The company is into tyre bead manufacturing – a very niche segment.
The company is the only bead wire manufacturer in Thailand (via a wholly owned subsidiary). It has a market share of over 50% in India. Over the years, the company took huge capacity expansions to drive future growth. The results are a 140% bagger.
Over this time, the country has seen a crash in small caps, a deadly pandemic, supply chain shortages, inflation, and even slowdown in the auto sector which is the prime industry the company caters to.
None of this has come in the way of the stock’s performance. That’s the beauty of investing in fundamentally sound small-cap stocks, having patience, and the power of long-term investing.
- Identify a shareholder friendly firm
Ensure your chosen company has a promoter holding of at least 30%. This much holding ensures that the promoter has skin in the game and that the company pays regular dividends. Dividends form an important part of the investing journey. They provide a steady income stream and help you build wealth over time. The key here is to look for small cap companies that have stood out in tough times and rewarded investors with regular payouts. But this won’t be valid for high-growth stocks.
In addition to shareholder-friendly policies, you’ll want to consider the promoter’s background. Educational qualifications do not give the investor an idea about the shareholder friendliness of the promoters. Shareholder friendliness is reflected in the character and integrity of the promoters/management.
Even stock market courses online free with certificate tells that it could be simply done by googling. It is essential to search for the name of the company with certain keywords like “Fraud, Issues, SEBI, Dispute, Court etc.” Also check for board of directors. There should be a healthy mix of executive and non-executive directors. At least 50% of the board should have non-executive directors or independent directors. Also check for the tenure of the board as longer the tenure, the stronger the board.
For example: If you check the board of directors of RajRatan Global Wires, out of 6 Members in the board ,4 are non-executive or independent directors. Promoter holding in the organization is also 65.10%. All these measures will protect you from fraudulent management.
Again, there are many ways to measure the valuation of a small-cap stock, but the two most common are the price-to-earnings (P/E) ratio and the price-to-earnings growth. To analyse the valuation of the stock, one must look at metrics like the P/E ratio, price-to-earnings growth, and other valuation multiples to assess whether the stock is undervalued or overvalued. One can learn these methods from stock market courses online free with certificate.
When analysing valuation small-cap stocks, consider the following points:
- Historical Data: Compare current ratios to historical averages to identify any significant deviations.
- Peer Comparison: Compare the ratios with those of similar companies within the industry to assess relative valuations.
- Growth Assumptions: Be cautious when using the PEG ratio, as overestimating or underestimating growth rates can lead to skewed valuations. see that the PEG ratio is less than 1.5 times.
It’s not easy to find the next 100-bagger, of course, but you’re looking in the right place with knowledge from top 5 Online Stock Market Courses in India, if you’re considering small-cap stocks. By investing in good small caps, individual investors can give themselves an advantage over institutional investors. These big investors tend to avoid stocks of this capitalization, as they aren’t big enough for them to make significant investments that would move the needle on their portfolios. We hope now you’ve understood how to find small cap stocks in India.