Stack Wealth 2024 Investment Strategy: The Overheated Small Cap Zone

Small cap companies will not give you the returns you're expecting in 2024. But before we unravel the current dynamics surrounding small caps and their overheated nature, let's take a moment to understand the meaning of a company's market capitalization.

View the other parts of this report here:

• Debt Markets are expected to do well: The Repo Rate Story
• An emerging opportunity: The Rising Affluent Class

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Understanding Market Capitalization

Market capitalization, casually known as "market cap," is your quick measure of a company's worth in the stock market. Picture it like sizing up a pizza joint – it's the total value of all the slices up for grabs. Each slice, or share, represents a piece of the action.

The more slices (shares) you can trade on the market, the higher the "shares outstanding." To get the whole pizza value, you just multiply the stock price by the total number of slices (shares). It tells you about the company's worth in the stock market.

Large Caps

• Large-cap companies typically have a market capitalization exceeding ₹20,000 crore.
• They are often well-established, stable companies with a history of reliable performance.
• Investors often turn to large caps for stability, steady returns, and lower risk than smaller counterparts.

Mid Caps

• Their market capitalization usually ranges from ₹20,000 crore to ₹5,000 crore.
• Mid caps are seen as a middle ground, offering growth potential and stability.
• Investors eye mid caps for opportunities to benefit from growth while maintaining a somewhat lower risk profile.

Small Caps

• Their market capitalization typically falls below ₹5,000 crore.
• Small caps are often characterized by higher growth potential but come with higher risks due to their relative volatility and susceptibility to market fluctuations.
• Investors attracted to small caps are usually seeking substantial returns and are willing to take on a higher level of risk.

Now, armed with a basic understanding of these market segments, let's dive into the current complexities surrounding small caps and the reasons behind their recent surge in popularity, as well as the potential pitfalls that may lie ahead.

Small Cap Inflow Trends and Overheating Signs

Approximately ₹16 to 17,000 crores are flowing into Systematic Investment Plans (SIPs) every month, with a significant portion, almost ₹3,000 crores, directed towards small caps alone. 

The cumulative flows into small caps over six months now surpass the combined inflows into mid and large caps equity mutual funds. This substantial influx hints at a potential overheating scenario as the market struggles to sustain such large flows over an extended period.

Abnormal Returns and the IPO Bubble

The last three years have seen not only positive returns but exceptionally high returns in mid and small caps. For instance, in 2021, small caps more than doubled, followed by a 37% increase, and another 40% surge in the subsequent year. Such a streak of high returns cannot continue forever. 

Furthermore, the IPO market is experiencing a bubble, with retail investors showing an unprecedented eagerness to invest. This is coupled with a lack of due diligence, leading to the influx of poor-quality and shady companies.

Proprietary Analysis & Small Cap Return Expectations

We analysed about 1900 stocks listed on the BSE, looking at their performance from the March 23 lows to December this year.

Observation: Over seven months, only 10% of the stocks gave negative returns. That means 90% of the stocks have given positive returns.

This is a very, very abnormal feat and not a very normal market environment. This is not something which can continue forever.

Conclusion: This tells you that an average 20-stock portfolio would have given a return of 50% in the last seven months. These are extraordinary times; such returns don't keep coming by now and then. 

Small Cap Return Expectations: Proprietary analysis suggests that the next 1 to 3 years for the small-cap index could be challenging, with muted sustainable returns expected.

In contrast, large caps, often overlooked, are poised for potential growth as money from small caps is likely to flow back into this segment.

A Shift towards Large Caps

The BSE 100 and BSE 200, representing the top 100 and top 200 listed companies in India, have underperformed compared to small caps. However, this presents an opportunity for investors, as large-cap companies are now relatively undervalued. As small caps start to underperform a lot of that money will flow back into large caps.

2024 will be a year where you will expect a decent amount of returns from large-cap stocks as they continue to deliver earnings growth and relative undervaluation vs mid caps and small cap stocks.

Large & Midcap Portfolio: Our Recommended Offering

Given the current overheating of small-cap stocks and the anticipated outperformance of large caps, Stack Wealth has a tailored solution for you.

Our team of experts has meticulously curated a mutual fund portfolio that directs your investment towards stable, large-cap companies exhibiting reasonable growth at prices aligned with their track record of profitability. 

Emphasizing large-cap entities, particularly in the burgeoning segments of the economy, our Large & Midcap Opportunities portfolio offers a strategic avenue for investors seeking well-grounded opportunities.