Investing in SME Companies – Is it your cup of tea?

By     |     June 10, 2018     |     1 Comment

Around 5 years ago, SEBI introduced the concept of SME platform in the stock exchange for small and medium enterprises to raise fund from the capital market. BSE was the first to attract multiple SME companies in the capital market. Till date, more than 350 companies are listed in the SME exchange (both NSE and BSE). The number of SME companies coming out with IPOs are increasing day by day with the increased investor’s participation. Around 15-20 SME companies are coming up with IPOs almost on every month and the number is increasing. In this article we are covering the advantages and disadvantages of investing in SME companies and whether it would be suitable for you or not.

Advantages of Investing SME companies –

Investing in SME stocks is like investing in the early age small startups. The risk of business failure is very high. At the same time growth opportunity is huge. In a country like India having the population of 1.3 billion (and growing) with the GDP growth rate of 7%-8%, these SME companies have huge growth potential due to the low base effect. Most of these companies have the turnover of few crores and a regional player. The opportunity is huge to enter the new market and multiply their business with the capital raised from IPO. With the able leadership and correct strategy, few SME companies can actually grow by 10-12 times over the next 3-5 years. Earlier, investing in the early-stage venture was limited to the venture capitalist, angel fund etc those can commit few hundred crores. Thanks to the SME platform, now investors with few lacs can also participate in early-stage small companies to partner with their growth journey. So, far sounds great, but wait the pitfalls are huge!

Disadvantages of investing in SME companies

The pitfalls of investing in SME companies are huge. Remember, there is no “Easy and Quick Money”. 10-12 times or more return potential from SME stocks comes with various pitfalls as follows-

No quarterly result, only half yearly result –

Unlike mainboard NSE/BSE companies, SME companies are not required to disclose quarterly result. They are required to publish only half yearly result. It means investors can know the current financial state of the company with a gap of 6-8 months. It essentially means if something goes wrong with the business or if there is cyclical downturn then investors will come to know very late. By the time, you will know about it the damage would have been done. There can be any kind of positive or negative shock in their half-yearly result. Moreover, the corporate governance standard of such small companies is far below than larger counterparts listed in the BSE/NSE mainboard segment.

Easy to Manipulate –

Due to the low liquidity, it won’t require a huge amount to manipulate the stock price of SME companies and profit from it by trapping other small investors. Whatsapp, Facebook, Twitter etc social media made the manipulation easy for operators. Many retail (small) investors jump in SME IPOs due to the greed of “quick money”. SME IPO size is generally few crores. Thus with relatively small amount SME segment is the perfect ground for operators. In the early days of 2014/2015, there was no such involvement from retailers and operators, quality SME IPOs hardly oversubscribed. Since 2017 with the increased retail participation, the involvement of operators increased and dubious SME IPOs started oversubscribing. Going forward, the operator’s involvement, manipulation can only increase in SME platform because in India multiple entities come in the stock market just to trap others for the profit. Sometimes in the game of trapping others, operators also got trapped by other operators!

No Escape route –

SME companies are like “One-way tunnel”. You can enter the tunnel, travel a long way in the search of gold mine. You might find the gold mine at the end of the tunnel but if something goes wrong you can’t escape. Either you will get lost or can be rescued with severe injuries. Similarly, after investing in SME companies, you need to hold for long-term for multifold return. However, during your holding period if something goes seriously wrong you may not get a chance to escape leading 100% loss! Click here to read another article mentioning how I lost 100% in one SME stock. Even if you can escape (exit), you will end up with a severe loss from SME stocks.

A bit difficult to research – 

There is no such brokerage/analysts coverage on SME stocks. The information is very limited (almost NIL) in the public domain. You can never actually know what is going on the mind of the promoter. All these factors made the research on SME companies a very difficult task. Moreover, Screener won’t help for screening/selecting SME stocks as there is no quarterly result and by the time you discover through the screener, the stock price should have already factored. All you have to do is just go through every listed SME companies, after spending the first 30-40 minutes you have to decide whether it is worth spending more time or not on the company. Spend more time and repeat the process of selecting/rejecting the company for further research. That’s the only way which is very time-consuming. There is no shortcut.

As you are saying chances of 100% loss (no escape route) so isn’t it gambling?

Absolutely not. Investment in SME companies is similar like investing in startups. Many of you must be aware that recently venture capital funds like Tiger Global, Softbank, Accel etc made a multi-folds return from Flipkart-Walmart deal. Now, if you follow the investment portfolio of Tiger Global, you will find many of their investment in start-ups failed i.e. 100% loss on invested amount. Venture capital fund invests in early-stage start-ups in such a way that even if many of their bet ends up with 100% loss then also just few bets can deliver multi-fold return to cover the entire loss from others. Investing in SME companies is similar like this, your investment should spread out in such a fashion that just few bets can cover-up the loss from others. It also doesn’t mean that if you pick any random 10-20 SME stocks it will serve the purpose. Remember, out of 100 SME stocks only 5-6 companies will make it huge and offer 10-20 times or more return for investors in the coming 3-5 years. Another dozen of stocks might move up due to market manipulation. Majority of them will either generate loss or remain small even in the long term. So, unless you are highly skilled with the correct temperament, you can’t make it big.

Still Want to invest in SME companies?

After reading all the advantages and disadvantages of investing in SME companies, if you still want to invest then consider the following points –

  1. One can invest in SME companies only if he can do the equity research by himself. Going by someone else’s research or buying just because someone else purchased is a real danger because if something goes wrong then the “more knowledgeable person” will exit first making exit route very difficult for those who purchased just based on someone else’s advice.
  2. If you invest just based on someone else’s research then most likely you don’t have enough conviction to hold for the long run due to the price volatility. Over the 2-3 years holding period, SME stocks generally experience 40% -60% or more downside from the peak or vice-versa. Sometimes even the stock doesn’t move at all over 8-10 months or more. Without personal conviction, it would be very difficult to continue holding.
  3. Investing in SME companies based on social media forwards (Whatsapp, telegram, Facebook etc) means the chances of losing money is 90%. As mentioned above with relatively smaller amount any entity can easily manipulate the stock price of SME companies and social media is the perfect platform for such manipulation to trap retail investors.
  4. SEBI mandates minimum investment of more than 1 Lac as a single lot for SME stocks so that small investors don’t participate. You can’t invest a single quantity of SME stocks. There is a certain minimum lot size. Many brokers don’t allow trading in SME companies to protect small investors.
  5. High net worth investors can invest using their own knowledge only if they can accept 100% loss from any misfired bet. There shouldn’t be any emotional attachment to the stocks and the money invested in it. You have to maintain “venture capitalist” mindset. The investment must be for the long-term (minimum 3 years) for earning 5-10 times (or more) return.

Are there any chances of advisory service from Paul Asset in SME companies?

No, Never, due to the following reasons –

  1. Maximum SME companies are smaller than microcap with very low free float shares. Shares worth only few lacs are available for daily trading in the market. Those shares are not even traded every day. It takes around 15-20 days or more while I make the personal investment in SME companies (same for selling). Thus, if we offer “Buy” call on any SME stocks, it would result in upper circuit for the next many days. It means without any fundamental reason the stock price can move up by 40%-50%. Similarly, if something goes wrong and we offer “Sell” call then the price might fall by 40%-50% by the time our members can actually sell. Offering public recommendation for SME stocks simply means price manipulation due to the low liquidity issue. So be aware if you come across any such “SME recommendation service”
  2. From the experience of running equity advisory service since 2012, I can say that although every small investor is eager for 100%+ return but the majority of them can’t even tolerate 30%-40% realised loss. In SME stocks, there is a chance of losing 100%. (Must read article – Why retail investors should stay away from SME stocks?) Thus by introducing paid advisory on SME stocks, I will do more harm than any benefits.

Many times, my name popped out in the shareholding pattern or bulk deal in few SME stocks. Thus many investors ask me about those stocks sometimes in the email, sometimes on Twitter and sometimes on Facebook. For multiple reasons, I avoid answering on social media. Going forward, I might put a general write-up on the SME companies where my shareholding is significant and available in public. There should not be any write-up or comments related to the stock price projection or financial valuation rather just a brief overview what the company do and what attracted me to invest in that stock. If you ask me anything about my holding SME companies over the email or social media kindly don’t expect any reply due to the potential conflict of interest.

Here goes the list of SME companies having a significant personal investment –

  1. KP Energy – Management visit note (Started investing since April 2017)
  2. Jiya Eco Products
  3. Lancer Container (write-up coming soon) – As per BSE website my shareholding is more than 1%
  4. MRSS, Focus Suites etc
  5. Few other companies (general write-up might be released later based on sole discretion)

Kindly note, many of you already asked multiple queries on my holding various SME stocks as my name popped out in BSE/NSE website for few stocks. Kindly don’t expect any reply on the stock price, future potential etc on those stocks due to the above-mentioned reason. It is highly recommended to do your own research. Always remember, investing in SME stocks just because someone else purchased can cause severe loss anytime.

By     |     June 10, 2018     |     1 Comment

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