What are SME Stocks?

Largecap stocks, midcap stocks, smallcap stocks, penny stocks, heck even microcap stocks... all these categories of stocks are widely discussed in the mainstream media.

The key thing is that these categories are well known.

For example, here's a simple chart that will explain the key difference between these categories.

Characteristic	Large-Cap Stocks	Mid-Cap Stocks	Small-Cap Stocks	Penny Stocks
Market Capitalization	Greater than ₹20,000 crores	₹5,000 to ₹20,000 crores	₹500 to ₹5,000 crores	Typically below ₹500 crores
Volatility	Generally lower	Moderate	Higher	Very high
Investment Risk	Lower	Moderate	Higher	Highest
Growth Potential	Steady, slower growth	Good balance of stability and growth	Higher growth potential, but more speculative	Potential for high returns, but very risky
Liquidity	High	Moderate	Lower	Often very low
Typical Investors	Institutional investors, conservative retail	Balanced investors, growth-oriented retail	Growth investors, risk-tolerant retail	Speculators, high-risk tolerance retail
Examples	Reliance Industries, TCS, HDFC Bank	Laurus Labs, Oracle Financial Services, PI Industries	Praj Industries, Goldiam International, Capacite Infrastructure	Suzlon Energy, Jaiprakash Associates, Reliance Power

Source: Equitymaster

While all these stock categories have already gone mainstream, there's one category of stocks that has seen renewed investor interest in recent months.

It's none other than the small and medium enterprises (SME) space.

Due to their so-called illiquid status and limited information available, these stocks were shunned big time.

But now, the index tracking these small companies has scaled a new all-time high.

Small and Medium Enterprises (SME) stocks are shares of companies that, despite their smaller size compared to corporate giants, play a crucial role in economic development, job creation, and technological advancement.

Understanding SME Stocks

SME stocks refer to the shares of small and medium-sized enterprises that are listed on a stock exchange, typically on a dedicated SME platform.

These platforms are designed to provide smaller companies with easier access to public markets, enabling them to raise capital for expansion and growth.

In many countries, including India, the UK, and the US, specialised SME exchanges or segments have been established to cater to the unique needs of these enterprises.

Characteristics of SME Stocks

1. Volatility: SME stocks are often more volatile than those of larger companies. This is due to their smaller market capitalisation, which can lead to larger price swings in response to market events or company-specific news.
2. Growth Potential: Many SMEs are in the early stages of their business lifecycle, which means they have significant potential for growth. Investors in SME stocks can benefit from this growth, although it comes with higher risk.
3. Limited Liquidity: Due to their smaller size and lower trading volumes, SME stocks may have limited liquidity. This can make it harder for investors to buy or sell shares without affecting the stock price.
4. Innovation and Niche Markets: SMEs often operate in niche markets or are involved in innovative industries. Investing in SME stocks can provide exposure to unique sectors and emerging technologies.

Benefits of Investing in SME Stocks

1. Diversification: Adding SME stocks to a portfolio can provide diversification benefits, as these stocks may have different risk-return profiles compared to larger companies.
2. High Growth Potential: Investors have the opportunity to invest in companies during their growth phase, which can lead to substantial returns if the companies succeed.
3. Supporting Entrepreneurship: Investing in SME stocks contributes to the growth of small and medium enterprises, which are vital for economic development and job creation.

Some Risks to Consider...

1. Higher Risk: The smaller size and limited financial resources of SMEs make them more susceptible to economic downturns and market volatility.
2. Information Asymmetry: There may be less publicly available information about SMEs compared to larger companies, making it more challenging to assess their financial health and growth prospects.
3. Regulatory Risks: SMEs may face regulatory hurdles and compliance issues, which can impact their operations and stock performance.

Recent Trends in the Indian SME IPO Segment

Note that investors are falling head over heels towards the SME space as these companies are churning out multibagger returns in less than a week... sometimes even doubling the initial money on listing day itself.

Here's a chart comparing the performance of the SME index to the main indexes tracked by Indian investors, i.e., BSE Sensex, NSE Nifty, and the broader indices of small-caps and midcaps.

As you can see, even after considering the rally witnessed during the pandemic, the SME segment has outperformed other indices by a huge margin.

Performance Over Different Periods

Index	Current Price	YTD (%)	1 Year (%)	3 Years (%)	5 Years (%)	10 Years (%)
S&P Bse Midcap	38,264.3	3%	60%	91%	151%	468%
S&P Bse Sensex	72,748.4	1%	26%	46%	90%	233%
S&P Bse Smallcap	41,982.2	-2%	56%	105%	182%	525%
S&P Bse SME IPO	51,460.9	11%	112%	3,000%	2,811%	7,502%
Nifty 50	22,055.7	1%	30%	50%	92%	238%

Source: Equitymaster

The performance of this index has improved with each passing year.

In 2023, we saw 48 mainboard and 57 SME IPOs hitting the market. The SME IPOs, in particular, have become the talk of the town and have caught the attention of investors.

One big reason behind this surge is the active involvement of retail investors.

People like you and me dear reader, are showing a lot of interest in SME IPOs, contributing to these mind-blowing oversubscription numbers.

So, what does this data tell us?

It's pretty simple. Investors are very optimistic for SME IPOs, and there is a good reason for it. The market is in a bull run.

Due to these oversubscription numbers, there's a good chance that these companies may list at a massive premium price when listed.

Also, we should give these SME firms some credit.

Many companies just approach and work their way around products by doing so locally and focusing on the problems that some other companies might already be solving.

But some companies are working on internalising certain core concepts, universal principles, and integrating the technical landscape.

The past year's debuts in the SME segment showed some unique businesses that focus on these points.

And if you find one such SME gem, be sure to hold on to it for the long term as long as the fundamentals remain intact.

But all of this comes with some warning signs...

# Huge Lock-in Amount

Now we know that retail investors are flocking to the SME IPOs segment looking for quick listing gains.

But these SME IPOs are not like mainboard IPOs as they demand a high minimum investment amount of over Rs 100,000. This is close to tenfold of the typical investment that investors make in the mainstream IPO segment.

So, a huge amount is getting locked-in which poses higher risk for retail investors.

What if the markets crash on the day of the SME IPO's listing? Would it fare well in this case?

We don't know... but we do know that you should not solely rely on subscription numbers and grey market premium (GMP).

# What if the Markets Peak Out?

There is a popular saying which goes, 'Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.'

If something like this happens, this can be a cause of concern for SME IPO investors.

We know that the performance of an IPO depends a lot on the overall market sentiment. If the sentiment is bullish, there is greater appetite for investment and investors often get trapped in the greed cycle.

If the markets peak out, the current excitement around IPOs and the big listing gains could backfire investors' portfolios and a huge lock-in amount follows high risk.

Hence, investors must keep in mind that SME IPOs can be a double-edged sword... ultimately, you should conduct due diligence before taking a final call.

# Beware of the IPO Bubble

As an investor, you must not get caught up in the IPO frenzy but rather study the underlying fundamentals of the company and also look at valuations and how it compares with the listed peers.

A good way to select stocks is to look for these parameters, so you could do them for SME stocks as well:

• Stocks with no promoter pledging.
• High promoter stake (preferably above 45%).
• Low debt to equity (preferably below 0.8 times).
• High ROE and ROCE (preferably above 15%).
• Low cash conversion cycle (below 100 preferably) and low receivable days (preferably below 90).
• And of course, also look for consistency in operating profit margins.

Fundamentally Strong SME Stocks to Watch out in 2024

We went one step further and ran a query on the entire universe of SME stocks, filtering them by the parameters mentioned above.

Here's a list of SME stocks where prospects look promising from a fundamental perspective.

SME Stocks to Watch Out

Company Name	ROE (%)	ROCE (%)	Debt to Equity (x)	Receivable Days	Promoter Holding (%)	Current Price (Rs)	Market cap (Rs m)	TTM PE (x)	TTM P/BV (x)
All E Technologies Ltd.	15.1	19.8	0.0	51.9	50.0	256.1	5170.7	34.9	5.1
Alphalogic Industries Ltd.	84.5	62.8	0.9	32.4	73.7	178.6	1819.8	82.9	7.1
Amiable Logistics (India) Ltd.	25.1	29.6	0.4	21.6	69.9	73.0	127.6	11.8	1.9
Anlon Technology Solution Ltd.	29.4	37.6	0.1	64.1	69.3	429.9	2409.6	54.3	9.5
Annapurna Swadisht Ltd.	23.7	23.4	0.4	29.7	49.0	323.0	5680.7	79.5	6.0
Arham Technologies Ltd.	27.1	25.1	0.6	78.1	73.1	207.0	1751.2	49.3	9.2
Aristo Bio-Tech and Lifescience Ltd.	15.8	16.1	0.7	65.2	73.4	72.2	491.2	13.8	1.6
Asarfi Hospital Ltd.	24.9	26.2	0.4	59.0	61.2	60.3	1186.0	14.8	1.7
Aurangabad Distillery Ltd.	28.9	29.6	0.6	6.0	74.9	246.0	2017.2	12.0	3.0
Basilic Fly Studio Ltd.	155.6	170.7	0.1	52.1	59.9	372.8	8662.7	32.8	9.0
Benchmark Computer Solutions Ltd.	17.1	18.9	0.4	60.4	72.3	54.0	370.7	18.3	1.2
Beta Drugs Ltd.	21.7	27.9	0.1	86.6	66.7	1279.2	12298.0	65.4	12.8
Bondada Engineering Ltd.	19.1	18.8	0.6	94.2	63.3	776.3	16768.6	164.1
Chaman Metallics Ltd.	29.7	31.7	0.3	18.0	73.6	83.0	2003.2	11.7	2.6
Committed Cargo Care Ltd.	20.4	27.5	0.0	67.2	98.0	59.5	643.2	12.1	1.2
Crayons Advertising Ltd.	36.4	42.0	0.2	80.7	73.5	182.5	4458.5	26.9	4.7
Cyber Media Research & Services Ltd.	21.1	22.5	0.6	80.0	42.2	142.0	415.8	21.7	3.2
DK Enterprises Global Ltd.	19.0	19.6	0.2	28.3	73.3	61.1	458.7	12.0	2.1
Ducol Organics & Colours Ltd.	15.0	20.3	0.2	53.9	57.4	96.1	1396.6	22.8	2.4
Emkay Taps And Cutting Tools Ltd.	21.7	27.3	0.0	63.8	75.0	620.0	6616.2	15.0	2.9
Essen Speciality Films Ltd.	16.9	17.8	0.1	48.2	70.1	179.3	3710.3	27.7	2.3
Exhicon Events Media Solutions Ltd.	73.0	91.1	0.1	76.3	62.3	314.2	4072.8	70.5	6.2
Fidel Softech Ltd.	22.8	29.8	0.0	85.4	72.8	113.0	1553.8	25.4	4.2
Frog Cellsat Ltd.	17.5	23.9	0.0	65.2	74.4	141.1	2178.0	16.6	1.8
Global Pet Industries Ltd.	24.5	33.3	0.0	27.3	72.4	92.2	901.9	45.1	4.0
Goldstar Power Ltd.	16.7	17.2	0.5	75.4	72.9	15.6	3743.0	100.4	12.9
Hemant Surgical Industries Ltd.	41.6	44.9	0.3	54.9	73.6	133.2	1390.1	18.2	2.9
Hi-Green Carbon Ltd.	63.2	54.3	0.6	24.6	71.8	173.0	4323.3	39.9	5.8
Holmarc Opto-Mechatronics Ltd.	35.9	44.1	0.1	67.4	62.7	92.0	924.6	26.0	4.0
Infollion Research Services Ltd.	40.6	55.0	0.0	49.6	51.7	192.4	1864.0	43.8	5.5
Innokaiz India Ltd.	54.7	69.2	0.1	25.0	72.0	51.4	525.2	5.9	1.1
Innovana Thinklabs Ltd.	26.6	35.6	0.0	0.0	73.2	505.0	10352.5	59.6	10.4
Integrated Personnel Services Ltd.	15.9	17.1	0.8	70.6	69.1	175.0	1261.1	37.6	4.5
Jainam Ferro Alloys (I) Ltd.	31.1	43.2	0.0	14.8	73.5	130.0	1373.0	5.9	1.6
Jeena Sikho Lifecare Ltd.	41.6	53.3	0.0	27.8	67.9	805.6	20027.3	59.4	14.6
Kalyani Cast-Tech Ltd.	78.6	84.0	0.2	22.2	69.8	455.0	3267.1	40.6	7.4
Kotyark Industries Ltd.	27.5	33.6	0.2	31.2	69.2	1040.3	10693.4	93.3	10.0
Magson Retail & Distribution Ltd.	33.6	36.7	0.3	5.8	70.1	90.0	706.5	28.0	3.1
Master Components Ltd.	15.8	20.8	0.1	76.4	72.5	137.5	550.0	32.3	2.1
MOS Utility Ltd.	32.0	31.1	0.3	7.9	64.7	139.0	3466.0	61.0	4.6
Network People Services Technologies Ltd.	25.8	34.4	0.0	26.3	67.6	1106.9	21458.4	329.1	40.4
Nirman Agri Genetics Ltd.	27.1	26.6	0.0	52.9	66.1	201.0	1197.8	29.9	3.5
Omfurn India Ltd.	16.4	18.5	0.4	83.9	73.4	87.0	710.8	18.2	2.6
Oriana Power Ltd.	47.0	50.5	0.4	75.3	61.4	691.8	13269.6	104.6	12.5
Party Cruisers Ltd.	18.4	23.4	0.1	27.6	73.1	120.0	1348.0	35.3	4.8
PE Analytics Ltd.	15.0	20.1	0.0	69.0	70.2	227.0	2379.4	26.5	3.7
Phantom Digital Effects Ltd.	65.5	75.1	0.2	61.9	63.9	482.8	6556.0	40.5	4.7
Prolife Industries Ltd.	23.9	29.9	0.1	63.8	73.7	230.9	945.3	13.7	2.9
Pulz Electronics Ltd.	31.6	43.1	0.0	40.6	73.3	122.0	1330.3	25.7	7.0
Quicktouch Technologies Ltd.	74.5	86.8	0.2	88.8	65.7	197.0	1138.4	17.8	5.1
RBM Infracon Ltd.	18.5	19.9	0.5	74.7	72.5	603.8	6099.7	275.9	7.1
Remus Pharmaceuticals Ltd.	66.1	68.8	0.4	31.5	69.6	5670.0	8351.8	98.2	12.5
Rox Hi-Tech Ltd.	93.0	63.8	0.9	48.2	58.9	119.1	2719.8	17.7	2.9
Saakshi Medtech & Panels Ltd.	34.4	33.3	0.5	60.4	73.6	209.5	3698.9	29.9	3.8
Sahana System Ltd.	83.5	75.4	0.4	90.7	62.9	742.6	5937.8	92.8	13.6
Service Care Ltd.	45.6	34.0	0.2	45.5	73.2	61.5	707.2	16.1	2.1
Shelter Pharma Ltd.	53.7	67.4	0.1	49.5	56.9	51.7	597.6	10.3	2.0
SKP Bearing Industries Ltd.	44.5	45.6	0.1	80.7	73.5	241.2	4003.9	30.2	9.7
Sotac Pharmaceuticals Ltd.	48.3	29.8	0.9	75.7	72.9	122.1	1349.2	30.0	2.8
Spectrum Talent Management Ltd.	69.7	45.3	0.1	23.2	73.7	83.0	1916.7	7.1	1.2
Srivasavi Adhesive Tapes Ltd.	18.3	23.1	0.1	69.6	73.2	116.5	1651.3	45.6	5.7
Systango Technologies Ltd.	32.6	39.0	0.0	17.3	72.0	323.0	4737.3	36.9	7.7
Techknowgreen Solutions Ltd.	71.2	70.4	0.5	82.2	65.6	178.8	1319.7	29.2
Timescan Logistics (India) Ltd.	25.6	32.6	0.1	43.4	72.9	125.0	436.8	11.7	2.7
Vasa Denticity Ltd.	70.5	80.1	0.1	3.5	69.6	491.0	7864.0	103.5	11.4
Womancart Ltd.	16.3	18.1	0.4	70.6	57.4	114.5	481.6	102.4	3.0
Yudiz Solutions Ltd.	31.3	43.6	0.0	45.1	73.7	80.4	829.2	30.1	1.5
Zeal Global Services Ltd.	63.1	57.7	0.9	46.5	73.4	205.1	2729.8	27.9	4.8

Data Source: Ace Equity, Equitymaster

Please note, these are NOT recommendations in any way.

Also, these stocks are filtered using the constituents of NSE SME Emerge index and BSE SME IPO index.

The market regulator recently said there were signs of manipulation in the SME segment and that it's working on ways to curb the same based on the market feedback.

The market regulator is also monitoring price manipulation instances in IPOs and said that it may consider implementing disclosures as a starting step with respect to SME IPOs.

In Conclusion

SME stocks represent a unique investment opportunity, offering potential for high returns but accompanied by higher risks.

For investors willing to embrace volatility and support the growth of small and medium enterprises, these stocks can be a valuable addition to a diversified portfolio.

As with any investment, thorough research and a clear understanding of the risks involved are essential when venturing into the world of SME stocks.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here.