Features and Benefits of Small Cap Stocks

What Are Small Cap Stocks in India?

 

Small cap companies are relatively small and in the early stages of their development. In India, small cap stocks tend to belong to companies with a market capitalization of below Rs. 5,000 crore. These stocks have high growth potential but come with considerable risks.

 

Market capitalization refers to a company’s market value based on the total number of its outstanding shares. The market regulator SEBI has defined large cap, mid cap, multi cap and small cap stocks based on their market caps. Businesses that rank 1st to 100th are large-cap, 101st to 250th are mid-cap, and those below 251st are small-cap companies.

 

 

Small-cap businesses usually have the potential to expand, so their stocks can outperform large-cap stocks in a bull market. Historically, they have proven to beat when the economy recovers after a recession. However, these stocks come with high risks as these companies may be unsuccessful over time.

Small cap companies have a history of underperformance, and their share price tends to be highly responsive to market fluctuations. During times of recession, these stocks usually deliver negative returns. These stocks are ideal for investors with a high-risk appetite looking for substantial profits.

 

You can compare the performance of a small-cap stock against its benchmark index. Two  examples of such indices include the BSE Small cap index and the Nifty Small cap 100 index.

 

Features of Small Cap Stocks

The following are some of the features of small-cap stocks:

 

• High volatility

 

Small cap shares tend to be more volatile than mid-cap or large cap shares. These shares are more vulnerable to market corrections than large cap stocks as these companies have lower revenue streams and less diversified operations. The small cap share prices increase significantly when the markets are bullish but underperform in bearish markets.

 

• High potential returns

 

Small-cap stocks are one of the highest-yielding investment options. These stocks can potentially become multi-baggers delivering over 100% returns in favorable markets. If you choose the correct stocks, you can get handsome payouts after holding them for the long term investment.   

 

• Low liquidity

 

Small-cap shares tend to be less liquid than mid-cap or large-cap shares. These companies are relatively new, and few investors know about them, resulting in fewer buyers and sellers. This is why small cap stocks are not suitable for short-term investments. Their liquidity and price discovery tend to improve over time.

 

• Low price

 

Small-cap companies are often undervalued due to their lack of recognition. With time, such organizations gain recognition and acquire more capital as they expand. If you can buy small cap shares with solid fundamentals at an affordable price, you can make significant returns when these stocks appreciate.

 

• Room for growth

 

All the mid-cap and large-cap companies of today are small cap companies of yesterday. Many small-cap companies have the potential to become mid-cap companies in the future and thus offer vast growth opportunities. Their wealth generation opportunity makes them an attractive investment option.

 

Differences between Small Cap Stocks and Penny Stocks

The following table lists the important differences between small cap stocks and penny stocks.

 

Parameters	Small Cap Stocks	Penny Stocks
Definition	These are stocks of companies that rank from 251st and below	There is no definition of penny stocks in India. It usually includes stocks with prices below Rs. 10
Market capitalisation	Below Rs. 5,000 crore	Below Rs. 1,000 crore
Traded at	Most small cap stocks are listed and traded on the stock exchanges	Often trades at OTC (over-the-counter) bulletin boards
Share price	Higher share price than penny stocks	Very lower share price
Risks	Associated with lower risk than penny stocks	Associated with very high risk
Liquidity	Has higher liquidity than penny stocks	Very low liquidity and infrequently traded

 

How to Invest in Small-Cap Stocks?

 

You can invest in top small-cap stocks in the market on financial platforms like Kuvera. You can also invest in these stocks through small cap funds, which offer the benefits of a diversified portfolio and expert money management.

To invest in small cap stocks using the Kuvera platform, follow these steps:

 

Step 1: Open the Kuvera app or visit the official website of Kuvera.

Step 2: Sign in using your credentials or register if you are a first-time user.

Step 3: Click on ‘Stocks’ in the Explore section.

Step 4: Type the name of the small-cap stock and click on it.

Step 5: Click on ‘Buy Stocks’ and enter the number of shares you want to buy.

 

What Are the Risks of Investing in Small Cap Stocks?

 

Small-cap shares can generate high returns, but they are highly susceptible to market risks. The following are some of the common risks investors should watch out for:

 

• Value traps: An investor can fall into a value trap when a company continuously operates with lower profits and has limited cash flows. As the company remains in this phase for a long time, investors may keep waiting till it turns profitable. If this continues for an extended period, the company may turn defunct.

 

• Market cycle trap: Small-cap stocks may perform exceptionally well during an up-cycle. However, if the financial bubble bursts, these stocks are severely impacted. Investors need to be careful about investing in the proper market cycle.

 

•  Regulatory or legal problems: Small-cap companies are prone to going bankrupt if they face any regulatory or legal problems due to their small size. That is why investors may want to avoid companies having such problems.

 

When investing in small-cap stocks, you will want to mitigate the risks by making other investments. It is good to pick companies with high revenues, profit after tax, and low debt. Furthermore, companies with a dominant market share and operating in niche segments are also good picks.

When investing in stocks, you will want to take a level of risk you are comfortable with. Aggressive investors willing to wait long to realize their gains can support a decent amount in these stocks. Conservative investors will want to limit their exposure to small-cap stocks.

 

Best Performing Small Cap Stocks in 2022

 

The following are some of the best small-cap stocks on the NSE Smallcap 100 as of May 16, 2022.

 

Name of the Stock	Low	High	Previous Close	% Gain
IRB Infrastructure Developers Ltd	Rs. 197.00	Rs. 212.20	Rs. 193.60	9.61%
Sobha Ltd	Rs. 515.00	Rs. 543.90	Rs. 506.90	7.04%
Sun Pharma Advanced Research Co Ltd	Rs. 210.15	Rs. 228.40	Rs. 210.06	6.95%
Birla Corporation Ltd	Rs. 952.75	Rs. 1021.00	Rs. 953.16	6.52%
Radico Khaitan	Rs. 760.95	Rs. 808.55	Rs. 760.60	5.70%
Jubilant Ingrevia Ltd	Rs. 431.00	Rs. 460.00	Rs. 457.80	5.74%
Sapphire Foods India Ltd	Rs. 1014.00	Rs. 1062.05	Rs. 1013.40	4.43%
MMTC Ltd	Rs. 38.65	Rs. 41.50	Rs. 38.60	4.79%
Brigade Enterprises Ltd	Rs. 408.66	Rs. 426.10	Rs. 407.90	4.40%
RBL Bank	Rs. 109.30	Rs. 116.25	Rs. 110.85	4.42%

 

Final Word

 

Small-cap stocks belong to companies with market caps below mid-cap and large-cap companies. These are the new and upcoming firms that offer the chance for investors to participate in the growth. You will want to do adequate research before investing in these stocks and diversify your portfolio to earn returns while mitigating portfolio risk.

 

 If you are interested in investing in stocks, download the Kuvera app now. 

 

Frequently Asked Questions

 

• 
  

      What type of investors will want to invest in small-cap stocks?

The following investors may prefer investing in small-cap stocks:

• • Those willing to wait for a long time, even up to a decade.
  • Individuals with an investment horizon of 5-7 years are recommended
  • Investors are looking for higher yields than large-cap shares in favorable markets.
  • Those who can bear a very high risk

• 
  

      What things should I look out for when investing in small-cap stocks?

These are some of the factors you will want to consider when investing in small-cap shares:

• • Cash flows and debt levels
  • Its operating profit margin
  • Liquidity ratios like the current ratio
  • A background check of the promoters and management team
  • Sales and profits for the last five years
  • The company’s performance against its peers
  • The business’s presence in its market
  • Its plans and potential

 

•     What are the differences between large-cap and mid-cap companies?

 

Large-cap companies are big and established in the stock market. In contrast, mid-cap companies are compact and have a size between large-cap and small-cap companies. While large-cap companies have a market cap of over Rs. 20,000 crore, mid-cap companies tend to have a market cap between Rs. 5,000 and Rs. 20,000 crore. Mid-cap stocks tend to be more volatile and risky than large-cap stocks but offer higher growth potential.

 

•     How is the market capitalization of a company calculated?

Market capitalization measures the valuation of a company. It is calculated as the total number of outstanding shares multiplied by the current share price.

 

•     How does a small-cap fund work?

Small-cap funds are equity mutual funds that invest at least 65% of their assets in small-cap stocks. These can invest the remaining amount in stocks with different market caps or debt instruments. These mutual funds benefit from a diversified investment by allocating the fund corpus to shares of companies in various sectors like textile, chemicals, construction, etc. Individuals with a high-risk appetite can invest in these mutual fund schemes.

 

Interested in how we think about the markets?

 

Read more: Zen And The Art Of Investing

 

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