Small was (more) beautiful in 2009

Mon, 21 Dec Pre-Open

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The year gone by was like a dream come true for stock market investors. This was not just because stock prices rose sharply during the year. The happiness was enhanced as these gains came after a scary 2008 that shook the markets' foundations. None were spared during that tough period for the world economy and markets. Investors and speculators were treated alike. Small investors, who had put in their life savings in stocks, were amongst the worst hit.  

We understand that all these words might bring back to you the bad memories. But hey, that was 2008!  

We are now closing in with 2009 - a year that has seen the return of risk-taking and triple digit gains across stockmarkets around the world.  

India hasn't been left behind. The BSE-Sensex has in fact been amongst the best performers across key world markets during the current year. Overall, the gains of 2009 have made investors happy and expectant of another great year 2010. And those who invested in small-cap stocks at the start of this year might be happier still.

After all, small-caps of all kinds have risen 3-5 times during this 12-month period. The BSE-Smallcap Index has outperformed all other key indices in rising around 115% during the year till date. These gains sparkle even when one considers the strong 100% and 75% returns of the BSE-Midcap and BSE-Sensex during the same period.  

One big reason we think led to this outperformance by small-caps was that these started the year on a very low base of valuations. The BSE-Smallcap index was trading at a P/E (price to earnings) of just around 6.2 times in January 2009. Against this, the multiple stands at 17.6 times currently.

Data Source: CMIE, Prowess
Given these low valuations of small-cap stocks in January, and that it requires little money to move small-caps (owing to their low liquidity), a gush of cheap money that came into Indian markets during the year made its mark felt more on this category of stocks.

Looking at 2010, we do not expect small-caps to repeat their performance of 2009. This is because these stocks (on an average) are now trading at valuations that are very close to those of mid cap and large cap stocks. For instance, the gap between BSE-Smallcap's P/E and Sensex's P/E currently stands at just around 18% as compared to 49% in January.

But this does not take away from the fact that there are numerous small companies out there, which are still available at attractive valuations as compared to their good long term prospects. One however has to be very cautious in search for such valuable opportunities. After all, it's not every day that we hear about a new small company that's doing great things.