Why are Smallcap Stocks Falling?

The BSE Sensex has been hit hard in the past weeks, falling by 4% in the last month alone.

Broader indices have also fallen suit. While the BSE midcap index has fallen over 3%, the BSE smallcap index has fallen by 5%.

This has been on the back of a variety of reasons, ranging from fears of a recession to geopolitical factors such as the Russia-Ukraine war.

The weakness in the market has been spurred by a 0.25% hike in interest rate by the US Federal Reserve to tackle high levels of inflation.

Given that CPI inflation has been 6.5% and 6.4% in the last two months, there is a good chance the RBI may raise interest rates as well.

In its last policy meeting held in February, RBI raised the policy rate or repo by 25 basis points (0.25%) to 6.5%.

Apart from this, the crisis in the banking sector also remains a big concern. While the crisis-hit banks have been bailed out, the after-effects may still continue to play out.

This issue is not restricted to a single sector. It has been widespread, affecting the global and local economies.

Small companies have been hit the hardest.

The current selloff hasn't spared the best of the performers.

We studied the performance of some of the top performing smallcap companies.

Here's what we saw.

Out of the 572 companies, only 120 show positive returns on a YTD (year to date) basis while the rest showed losses spanning up to 60%!

Company	Change (%)
Heranba Industries Ltd.	-46%
Jindal Poly Films Ltd.	-38%
Morepen Laboratories Ltd.	-35%
City Union Bank Ltd.	-33%
Excel Industries Ltd.	-33%
Balaji Amines Ltd.	-28%
Kitex Garments Ltd.	-28%
Dixon Technologies (India) Ltd.	-28%

Source: Equitymaster

Smallcaps have a reputation of being risky, unlike their larger counterparts. So, when the market sentiment is weak, they are the first ones to bear the brunt.

The reason behind this is simple.

When faced with uncertainty, you want to safeguard your money.

You don't want it invested in new businesses. Moreover, you want to be able to liquidate your holdings faster.

Therefore, during any economic crisis, investors dump smaller highly volatile stocks first, i.e. small caps and flock over to well-established and liquid companies, i.e. large caps.

This fall has led the smallcap index to trade at a relatively attractive value.

At present, smallcap stocks are undervalued relative to their historical levels as well as compared to largecap stocks.

The smallcap to Sensex ratio at present stands at 0.45x. This is against a long-term median of 0.44x, and against the previous peaks ranging from 0.54 to 0.76 in the last two decades.

Now, this may imply there is plenty of room for investors to generate significant returns over the long term.

And while there may still be some more carnage in within the indices, the long-term prospects look strong.

In conclusion

By keeping an eye on undervalued smallcap stocks and staying disciplined in your investment strategy, you can potentially find attractive opportunities.

But no matter how great the prospects of robust returns are, you must consider your risk appetite and investment horizon before making any investments.

That is what successful investing is all about.

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...