In the vast realm of investment opportunities, where industry giants like Reliance Industries, HDFC Bank, and TCS dominate headlines and portfolios, and mid-caps and small-caps draw their fair share of attention, there exists an uncharted territory brimming with untapped potential - microcap companies. However, investing in this lesser-known category has its fair share of myths and misconceptions. In this blog post, we aim to debunk the common myths surrounding microcap investing, separating fact from fiction.
Myth 1: Microcaps are penny stocks
One of the most prevalent misconceptions surrounding microcaps is the belief that they are penny stocks with tiny market caps. Penny stocks, although there is no formal definition, typically refer to stocks with very low share prices (less than INR 10) along with very small market caps and are often thinly traded. They are commonly associated with speculative, high-risk investments. In contrast, microcap stocks as defined by NSE are 250 largest stocks after the Nifty 500 index constituents. Based on current composition of Nifty Microcap 250 index, as of 30th June 2023, the largest and smallest company has total mcap of around INR 11,000 crores and INR 1,000 crores, respectively; further the median size of microcap is around INR 2,500 crore. These numbers suggest that microcaps are not comparable to penny stocks, highlighting the stark contrast between microcap stocks and penny stocks.
Myth 2: Most of the microcap companies are loss-making
One prevailing myth that hovers over microcap companies is the belief that their price performance may not be supported by earnings. Many people perceive microcaps to have negative or low earnings growth. People argue that these companies are non-profitable and inherently risky. This generalisation, however, fails to acknowledge the diversity within the microcap universe in terms of earnings and profitability.
Let's delve into the data to debunk this myth:
The data from Exhibit 1 & 2 paints an encouraging picture of microcap companies. As of 31 March 2023, the cumulative net income of microcap companies has surged from a modest ₹4,496 crores in 2017 to an impressive ₹31,544 crores. While the earnings of microcap companies may display volatility, it is noteworthy that as of 31 March 2023, out of the 250 microcap companies, 218 are profitable. This substantial proportion of profitable microcap companies challenges the prevailing belief that microcaps are pre-dominantly loss-making entities.
But that's not all. Let's focus on the bigger picture by examining the subset of microcap companies with substantial profitability. In 2017, an impressive 56 companies generated profits exceeding ₹100 crores. In 2023, that number has soared to around 137 companies. This substantial increase demonstrates that a growing number of microcap companies are profitable and are scaling their earnings to surpass the ₹100 crores mark.
Myth 3: Microcap companies do not outgrow to become large companies
Many people perceive microcap companies as stagnant entities that can't outgrow their small size. However, the data tells a different story. Since 2005, an impressive number of microcap companies have defied expectations and made remarkable transitions.
The data presented in exhibit 3 showcases the impressive transformations that microcap companies have achieved. However, investing in microcaps comes with inherent risks, as while some companies may successfully transition to larger market caps, others may face challenges and potential downward trends in market capitalisation.
In conclusion, exploring the myths surrounding microcap investing has shed light on the realities within this often-misunderstood and less researched investment segment. While the objective of this blog is to eliminate misconceptions or lesser-known facts, however, it is essential to acknowledge the risks associated with microcap companies, such as higher volatility, liquidity, and company-specific risks. While some investors have experienced substantial profits, others might have experienced losses in this space. One effective way to navigate through risks is to gain exposure in the microcap segment through a passive diversified mutual fund, which offers broad exposure to mitigate the company-specific risk. Additionally, adopting a long-term investment strategy such as SIP, can be a prudent way to address the volatility inherent in this segment.
Raghav Avasthi is Research Analyst - Passive Funds, MOAMC.
Source/Disclaimer: Niftyindices, MOAMC Research, FactSet. The above graph/table is used to explain the concept and is for illustration purpose only. It should not be used for development or implementation of any investment strategy. Past performance may or may not be sustained in future. This article has been issued based on internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The indices mentioned herein are for explaining the concept and shall not be construed as investment advice to any party.