Market cycles don’t matter if investors bet on the right small-cap stock at the right valuation for the long term. And they need to be more watchful as returns from the stock market are expected to moderate in 2018 compared to the previous year.
That’s the advice from Sumeet Nagar from Malabar Investments, which bets on small businesses and manages assets worth $600 million. Unlike 2017, where the “rising tide carried all boats, even the ones with leaks”, quality will start to matter a lot more, he said on BloombergQuint’s special series Alpha Moguls.
India’s equity benchmarks have fallen off record highs scaled early this year after a global selloff and the Finance Minister’s decision to tax long-term equity gains. S&P BSE SmallCap and MidCap indices have fallen more than 5 percent each compared with 0.5 percent gain in the benchmark Sensex so far this year. The index trades at the highest one-year forward PE multiple compared with Asian peers.
There is a possibility of earnings growth outpacing stock price performances, which will bring valuations to reasonable levels, Nagar said. Rising yields and liquidity reversal from major central banks will test investors, he said.
Investing in small and mid caps can help outperform the benchmarks, he said. But Nagar also cautions that investors must jump in with a long-term perspective because such companies take time to show their mettle.
Malabar Investments made two large bets in Safari Industries Ltd. and Hatsun Agro Ltd. Nagar said the company buys businesses that it can hold for 10-20 years. Cash generation, quality of business and the quality of promoters become the key criteria for stock selection. “Promoters should possess integrity, knowledge of business and capital allocation capabilities, in addition to creating a lower layer of management expertise.”
The focus will stay on small and mid-caps. Even smaller companies that operate well in niche areas can have moats and business advantages, giving attractive returns over a longer period, he said.
(Updates an earlier version after Malabar Investments clarified that it manages $600 million in assets and is backed by partners who manage $15 billion)