SME Stocks: Know these under-researched gems

Today’s article on AI Post is focusing on a niche segment of stocks within stock market. These are stocks listed on special platform of stock exchanges called as BSE-SME & NSE Emerge. The purpose of such platform is to enable entrepreneurs and small companies to raise capital from stock market and fund their next leg of growth. You will be surprised to know that this segment of stocks have given stunning results to investors. Over last three years, BSE SME IPO index itself has given an annualized return of 31% as compared to BSE Sensex’s 16%. Almost double.

Index NameAnnualized Return
BSE SME IPO31%
BSE Sensex16%

Going down to individual stock level within SME space, we have many multibaggers even in a bad year like 2018. Within 2018, stocks like Mittal Lifestyle gave 478%, Mac hotels gave 283% & Gautam Gems returned 247% just to name a few. If we extend our horizon up to 5 years time-frame, we have more than 25 multibagger stocks emerging from this segment. Now consider this – Till 2017, there were hardly 100 odd stocks listed on BSE SME platform. This implies a very high strike-rate of finding a multibagger from this segment. Theorically, 1 out of 4. Since 2014, Suyog Telematics gave 1700%, Kushal Tradelink gave 1740% & SRG Housing Finance 1553% returns to quote a few. All of them have now graduated to the main platform of BSE & NSE. With this migration, liquidity has improved and certain restrictions on their trade has gone away. We will cover all of this at a later stage in the article.

Coming back to the article’s heading, so there is a serious amount of money to be made from SME platform that is for sure. Surprisingly, we have not heard much about them in media reports. Possible reason is because there are very limited set of investors interested in SME stocks. Media mostly reports to the interests of general investors and not to the taste of specific set of investors. This can also be a reason that there is hardly any stock advisory service catering to this segment. Market supplies services which is in high demand. This concept is also very new to Indian investors while it is quite popular abroad. This means early movers will get the advantage.

At AI, we have observed this gap and that is why we are publishing about them so our ace readers are aware of this relatively new concept in equities. SME stocks are open to everyone and there is no reason why it should remain confined to a limited set of investors. May be lack of awareness & expertise is restricting wide participation in SMEs. There is no denying that it is highly rewarding but also a very risky segment to operate. Sensing this, we are launching a new stock advisory service, called as Emerging CAPS to fill this gap and enable small cap enthusiasts to benefit from these new opportunities. Ok, enough introduction. Let’s go into the details of SME stocks and how to deal with them.

About SME Platform

This platform was created so that more and more small & medium size enterprises can get themselves listed and access capital market. This creates a win-win situation as investors also get access to a wide range of companies with huge room for growth in future. This platform is probably the only place where you will find compelling business models trading with a market capital below ₹100 crores. So far we have about 292 companies listed on BSE SME exchange and around 100 more to join in next one to two years time-frame. So clearly there is a healthy pipeline to offer. To do a trade, you will not need any separate demat account, same account will work to buy these stocks as well.

Evolution of Retail Small-Cap Investor

Investors on SME platform are hardly retail folks. This section of stocks were being ignored by retail investors till last year. As we know, Indian stock market is still evolving. More small cap investors are maturing with each market cycle. This set of population is set to grow with time. Till 2013, there were hardly much investors for BSE small cap stocks, forget about BSE SME stocks. However things have changed and now we have many serious small cap investors. But what about SME small cap stocks? As per data, hardly few percentage (around 1%) of retail investors operate in SME segment. Clearly, ignored by retail investors due to lack of awareness.

Overlooked by Many Investors

The reasons why SMEs are overlooked can be many. Biggest is lack of awareness. Also prominent one is the fact that SME platform is a relatively new concept in India (launched in 2013). Few other reasons behind their unpopularity is listed below.

  • Minimum Lot size is ₹1 Lakh
    • Stocks under SME platform are traded in number of lots. Each lot need to have a minimum value of ₹1 Lakh. Let’s say if a stock is priced at ₹100, its minimum trading lot will have atleast 1000 or more share so that trading order value crosses ₹1 Lakh. For each stock, trading lot is defined by the exchange. This acts as a major deterrent as not many investors will have big enough portfolio to put ₹1 Lakh in a single stock. This means it is out of range for many (not all) retail investors who don’t want to put ₹1 Lakh in a single stock.
  • Too shallow for Institutional Investors
    • The average market capital in SME stocks is ₹63 crores. In fact, overall market cap of whole SME platform is ₹18,402 crores. Lesser than market capital of just Oil India. This means big institutional investors are also not interested in this segment. This also leaves lot of scope for growth as more money will flow into these stocks in future.
  • Less Liquid
    • The trading volume on any given day is few lakh rupees, with top volume going into few crores. Getting in and out of such investments can be tricky for big investors. To fix this for small investors, SEBI has mandated merchant bankers (who issues IPOs) to act as market maker by holding certain stocks with them to ensure enough liquidity for buy & sell orders.

But Lapped by Niche Investors

Investment pattern for HNI & Institutions are changing. Many institutions have become venture capitalist. Even celebrities are also supporting stat-ups like Ratan Tata, Yuraj Singh etc. They are funding startups when business is at initial stage and bag huge returns when they grow bigger. Unfortunately, most of these startup never get listed on Indian stock exchanges making it nearly impossible for retail investors to benefit from them. The second best option for retail investors with sizable money, can be SME stocks. These are companies which have grown beyond the start-up stage and are ready to grow their business like a normal enterprise.
Sensing this, many niche investors are involved in SME space. We call them niche because they are neither fund managers nor institutions, but individuals who are actively involved in SME platform.

  • Vijay Kedia, an ace retail investor is actively invested in many SME companies and has generated multifold returns from this segment.
  • Pantomath Advisory, which acts as merchant banker for SME IPOs (responsible for 60% of total SME IPO) gains first hand knowledge about company’s potential. Panthomath taps this knowledge by investing in SMEs via Alternate Investment Fund.
  • Geeta Ambani (not Nita Ambani 😉 ) an HNI investor and relative of Amar Ambani (Research Head-Yes Securities), is also actively involved in SME segment. Some of her picks gave her 10x returns in 2 years timeframe.
  • Sunny Porinju, son of Porinju Valiath is also an active investor in this space.
  • Chandir Gidwani, Founder of Centrum Capital. And many more.

These are a few names who are active in SME space. You can see none of them are actually associated with any institution but they are the next generation investors. Plus they are investing using their own capacity which shows the potential they foresee in this segment. If you can shell out ₹1 lakh, you can also join this niche segment. You just need two things, money and expertise. If you have the required money, we can help you on the expertise part via our new service called Emerging CAPS (more details below).

What makes SMEs so lucrative?

  • New-Age Business Models
    • Many businesses getting listed on SME platforms are new-age business with unique business models. Most companies have started business post 2000 era in which India’s economy has changed a lot. Consider this, there are companies which are purely working on industrial automation. Some are setting up solar power plants across the country. Some are working on IT analytics and partner directly with Google. Even Flipkart picked momentum post 4G era. These new business are more aligned to new economy because they have been created under modern era. It is difficult for an old business to quickly revamp themselves thus facing challenges from newer companies which are growing at a scorching pace. This makes SME segment very exciting for sophisticated individual investors.
  • Companies in Larva Stage
    • Like Larva, many such SMEs are still coming out of the shell and exploring bigger addressable market with fresh equity infusion. Investment done at this stage can be even more rewarding than small cap investment.
  • Not yet in Institutional Radar:
    • As explained above, these companies are yet outside of radar for most institutions. This gives a great entry opportunity for individual investor to grab multi-fold returns. As Warren Buffet regrets when he says that with his investment size he must stick with elephants (large-caps) and not mosquitoes (small caps). While, he knows he can double his money from Mosquitos (small caps). As a small individual investor, this is the edge you have over bigger institutions.

A Word of Caution

Along with lot of potential, SMEs are also riddled with huge amount of risks. There may be many companies listed in SME platform who do not have a sustainable business model. For example, some pharma companies engaged as contract manufacturer for large caps. Some IT companies engaged in generic software development & testing support. Then there are many financial / trading companies as well. Such companies lack any competitive advantage and may die with time or remain stagnated. So far they look successful on papers due to lower base. It is easy to setup a factory and turn your revenue from a few lakhs to 1 crore (almost 100 times growth). However, as soon as you grow beyond a certain threshold, competition from bigger players start to hinder next leg of growth.

Another concern can be liquidity. These are less liquid stocks with trading done in lots. At times if an investor wants to exit these stocks, his selling order can potentially trigger lower circuit if no buyers are available. The good thing is SEBI has directed market makers (IPO Issuers) to ensure enough liquidity during first three years of listing. This will enable confidence in the stock before share volumes pick up naturally.

Are SME stocks my cup of tea?

It depends on your risk / return profile. In general, we believe every small cap investor should be seriously considering SME investments as well. In developed markets, retail participation is healthy in SMEs. With time, it will pick up in India just like small caps investments did over last few years. Remember early bird catches the worm. If you are not sure, give a thought to below points.

  • If you are not comfortable with small cap investments itself, there is no point in considering SME investments at the first place.
  • The minimum investment size will be ₹ 1 Lakh and above. Typically, it will be ₹1.2~1.5 lakhs depending on stock’s lot size as determined by the exchange.
  • Risk associated with SMEs are even higher than small caps but so is the return. To give you a perspective, if small cap gives you 100% returns by taking a risk which is 6 out of 10. SMEs will gives you 2 to 5 times more return as compared to small caps by taking a risk of 8 out of 10.
  • Suited for aggressive investor who wants to create more returns by adding more risk. If investor can handle small caps with ease, then SME investment should not be a problem as well.
  • The investment horizon has to be 3-5 years to cover at least one full market cycle.
  • Investor will need to keep patience which is generally a quality ingrained into sophisticated investors. This is not a short term game.

Emerging CAPS: Our New Service

The universe of SME small caps is perhaps the most tricky in equities. For a small cap treasure hunter, this is also an unexplored goldmine with huge return potential. The key is to invest in right stocks at right price. Having a good selection process can separate gold from useless rocks. At AI, we have developed a very stringent criteria to evaluate SMEs. A few key parameters being evaluated are:

  • How big this company can grow: To avoid player who are into commodity business. The addressable market size should be good enough for a business to expand.
  • Capital Efficiency: Traits of a good management. Company can not grow rapidly if they keep on loosing capital per unit of revenue.
  • Business Moat & Sustainable Margins: Finding a business moat in a SME is rare as these companies are still building their moat as they grow bigger. However, a look at profit profile can indicate if their customers value their product. This usually translates in a business moat at a later stage.
  • Debt Levels: One of the biggest killers of small companies is corporate debt. These companies just can not sustain themselves when liquidity squeezes in financial system. Hence debt levels must be kept under control.
  • Industry Structure & Competitors: A look at industry structure can tell you if this industry favors smaller player or it is consolidated in a few hands. For example, telecom, airlines, etc.
  • Management Quality: Does management walk the talk? What is the experience of the management. The kind of exposure, they have in the industry. These things matter a lot. We prefer first generation management who are living their dream and running their own ventures. Such passion often creates wonderful returns for stakeholders.

We evaluated top 100 companies in SME space as part of our study using our selection criteria. The top 100 were selected in terms of liquidity, not market capital. These are few tweaks we need to do when dealing in SME stocks. The results were surprising as only 8 companies were able to clear our filters. In a way, this outcome is good since it ensures only the best of SMEs will be recommended as part of this service.

Pre-Launch Offer to Ace Readers

Due to nature of SMEs which often have low liquidity, we will be putting a cap on the maximum number of subscribers under this service. This service is not yet launched to the public and you will not find links on our website as yet. Also, we could’t find any other SME stock advisory service on the internet. So, this can be very well be the India’s first ever SME stock recommendation service.

We want to offer this service to our Ace Readers first, before opening to the general public. If you are interested in SME investment and find it appealing, you can join our service and secure your slot. Once we hit our maximum number of subscribers, we will have to stop accepting fresh customer. To join now, click on the blue button at the end of this article.

Salient Features of Emerging CAPS

  • Only SME stocks will be recommended.
  • Suitable for aggressive investors. High risk & very high return profile.
  • Multibagger return potential in next 3-5 years time-frame.
  • No fixed recommendation frequency. You can expect 3 to 6 stocks in one year. This can vary depending on market conditions. In SME space, it is better to look for quality and not quantity.
  • Complete guidance on new and older SME stocks recommended by us until subscription validity.
  • Service will be closed for fresh subscription once maximum ceiling is hit.
  • Introductory offer: ₹18000 for two years. Minimum tenure is two years. Service runs under blocks of two years each.
  • This is a standalone service which will not be clubbed into combo plans.
  • For any queries, contact us via WhatsApp on 9958092336 or email to acesales@aceequityinvestor.com
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