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Marcellus’ Pramod Gubbi’s Advice To Investors Drawn By This Rally

Investors need to be careful before investing in small caps, says Marcellus’ Pramod Gubbi.

A bronze bull statue stands at the entrance to the Bombay Stock Exchange (BSE) building in Mumbai India.
(Photographer: Dhiraj Singh/Bloomberg)
A bronze bull statue stands at the entrance to the Bombay Stock Exchange (BSE) building in Mumbai India. (Photographer: Dhiraj Singh/Bloomberg)

The unprecedented rebound after the pandemic-driven selloff has drawn retail investors to equity markets hunting for winning bets. Pramod Gubbi of Marcellus Investment Managers has one advice: beware of the dangers of investing in small caps.

“More demat accounts are opening and money is entering the market, but the rally will also create disappointments for investors who are unable to distinguish between good and bad businesses,” Gubbi told BloombergQuint's Niraj Shah in an interview. He cited the example of 2017.

“2017 showed that investors got lured into buying and investing in anything and everything, particularly the low-quality ones, which got doubled and tripled, during that period—only to lose 80-90% in 2018,” Gubbi said.

Since then, even after the rally in 2020, small caps have barely reached the 2017 levels, he said.

"The whole fascination about small caps is that it doesn’t have any basis in terms of data underlying it. Small caps have performed in line, slightly shifting lower than the Nifty or the Sensex, but they have provided the same sort of returns for significantly higher volatility,” he said. “From a risk-adjusted return perspective, there is no case to be built for small caps.”

While Gubbi said that a lot of investors make a lot of money by investing in small caps, he cited data analysed by Marcellus for investors to be cautious.

The firm divided small, mid and large caps into quartiles based on their performance. Small-caps companies with the best earnings outperformed the best-growing mid and small caps, he said. But, going down the quartiles, the worst small caps significantly underperformed the mid-and large-cap categories, both by share price and earnings, he said.

Gubbi advised looking at return on capital employed while investing in stocks. And he suggested companies that stand on their own irrespective of which way the macro wind is blowing.

Among the sectors, he sees an upcycle in automotive in three to five years. "We are at the beginning of auto cycle picking up," said Gubbi. Investors can consider high-quality automotive firms. Amid small caps, Suprajit Group stocks, Lumax Industries Ltd. and other four to five others are "shaping up well", he said.

Watch the full conversation here :