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Why The Big Price Destruction In Small Cap Stocks?


The writing was on the wall - at some stage mid and small cap stocks were going to collapse. For several months analysts had been warning that premium prices were not sustainable.


In fact, p/e multiples of even companies where the growth was tepid continued to be in the range of 50 times. The sharp and sudden decline, in some cases 50 to 80 per cent, has also seen some mutual funds seeing a sharp dip in their net asset values.

Several stocks have fallen to 52-week lows. Vadilal Industries, Rane Brake Lining, Z F Steering, Bannari Amman Sugars, IST limited, Blue Dart etc. Remember, each of these companies are blue chip companies.

Some of the others which were the favorite of fund managers, have seen severe price destruction. PC Jeweller shares have fallen from Rs 600 to Rs 129. On the other hand Avanti Feed, a blue chip name in shrimps and shrimp feed, has seen its shares drop by almost 40 per cent in the last few weeks. Again, this is a favorite of fund managers. Here are some reasons why these stocks have fallen.


Mutual funds recategorization

The Securities and Exchange Boars of India had issued guidelines for mutual fund recategorization.

This means, if you were a large cap fund and had exposure to small and mid caps, you needed to align your portfolio. This led to some sharp selling by mutual funds.

Valuation of mid cap stocks have always historically been higher

Due to political uncertainty and weak macros, many analysts are asking their clients to shift money to large cap space. This results in lesser price destruction and prevention of sharp capital erosion in case there is a sudden collapse in the markets.

Why The Big Price Destruction In Small Cap Stocks?

This is also on big reason, why we have seen a sudden collapse in stock prices of small and mid cap stocks.

Sharp recovery ruled out

It is unlikely that we will see a sharp recovery in stock prices of these companies, to historic levels seen in the month of Jan 2018. In fact, in that month prices were unbelievably high. Things look a lot uncertain now, then they were before.

Political uncertainty, especially the re-election of the Narendra Modi government in 2019, looks more uncertain then ever before. Corporate earnings at best are tepid and there is an interest rate hike that could be on the cards in either June or August.

Against this backdrop any vertical recovery in small cap stocks to Jan levels would be difficult to come by. Even if you are a long-term investor, it would be a good idea to buy small quantity only.

Story first published: Tuesday, June 5, 2018, 8:29 [IST]
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