Small cap stocks outperform benchmark indices on first-time investors' fancy

First-time investors, who became stock market participants during the Covid-19 pandemic, are seen to behind a strong rally in the hitherto overlooked small cap stocks.

Small cap indices of both the BSE and the NSE have clearly led the market rebound and outperformed the benchmarks by wide margins during the past five months, data from stock exchanges shows.

Analysts say a wide array of factors are luring new investors into the small cap space, including under-ownership by fund houses and playing out of new themes such as agriculture, chemicals and pharmaceuticals where small cap firms have a sizable presence.

"The small cap story is back with a bang with first-time market participants finding hidden opportunities in the space. Small caps led the market recovery from the March lows fuelled by elevated retail participation compared to the pre-Covid-19 levels," said Vinod Nair, Head of Research at Geojit Financial Services.

"Increased interests of foreign institutional investors in the space added more legs to the rally in small caps. In my view, we still have more headroom for trading in small caps. For instance, Nify50 is trading at one year forward price to earnings (P/E) of 22x compared to 16x of Nifty SmallCap 250 index," said Nair.

"Small cap index has quite clearly outperformed the Nifty 50 index during the past five months. Liquidity, under-ownership by fund houses and lower interest rates are the primary factors responsible for the out-performance," said S. Ranganathan, Head of Research at LKP Securities.

Between April 1 and August 24, Nifty SmallCap100 Index has notched up a gain of 63 per cent against the broader index Nifty50's rise of 39 per cent, while BSE 250 SmallCap Index rallied 57 per cent compared to Sensex's appreciation of 39 per cent.

"Certain segments of the economy like agriculture had a dearth of high quality listed large caps, hence the muted impact of the pandemic on agriculture began manifesting itself in several small and midcap stocks within the sector. Besides, several small cap stocks across a wide gamut of sectors have been beneficiaries of the protectionist measures on account of imposition of duties on imports and the 'Aatmanirbhar' drive in the wake of the pandemic making a genuine case for an up move in stock prices in the small cap space," Ranganathan said, adding that the small cap space is highly under-researched.

"Sectors like chemicals, pharmaceuticals and auto components have had positive tailwinds as a fallout of the pandemic and with small caps and midcaps constituting a large part of these sectors we have seen PE expansion as growth visibility appeared to be clear," Ranganathan said.

Even within the domestic consumption space which has seen the most adverse impact of the pandemic, the fall in stock prices of small cap stocks during March was more pronounced as compared to large caps which led to a return towards mean reversion during August, analysts added.