Largecap stocks won’t offer safe and steady return always
There is a widespread misconception that investing in large cap stocks are safe while it is risky to go for small caps and mid caps. Moreover, maximum investors believe that large cap stocks offer steady flow of return while mid caps and small caps are highly volatile and don’t offer steady return. It will be hard to accept, if I directly conclude that quality small caps and mid caps can offer more safety, better dividend yield and obviously better return than large cap stocks across any market cycle (bull and bear market). So, let’s go for detailed real life examples-
Large cap stocks /Small cap stocks-
State Bank of India (SBI) is a large cap, well-known, blue chip banking stock. It is also the largest bank of India. On the other hand City Union Bank (CUB) is a small-sized regional bank. Let’s have a look at the price performance of SBI and CUB across various economic cycle.
- After the financial meltdown in the year 2008-09, 2010 was marked as a turnaround year. Banking sector responds first during any economic turnaround. Against the 14.20% return of Sensex, throughout the 2010, City Union Bank(CUB) generated around 90% return while State Bank of India (SBI) generated around 27% return.
- Now, let’s have a look on the year 2011. Indian equity market performed poorly during 2011. Against the -25% return of Sensex, CUB generated marginal negative return (-5%), while SBI generated huge negative return (-40%).
- Moving forward to the year 2012 when Sensex generated 30% return. During the same period CUB generated around 52% while SBI generated 35% return.
- Similar trend continued in 2013. Current year (2014) is also no exception.
|CUB – Stock Return||90%||-5%||52%|
|SBI – Stock Return||27%||-40%||35%|
So, whether market moved up or down, a quality small cap banking stock (CUB) always outperformed the large cap and also the largest bank of India! Many analysts may suggest you to remain away from small cap stocks stating that small cap stocks move up faster during bull-run and also fall faster during bear run. There is a far-flung misconception that small cap stocks may offer better return but it can also lead to “unlimited loss”. But, the above illustrated example suggests a completely different picture. You may argue that the example of CUB and SBI is an exception. Well, compare Atul Auto (small cap auto stock) with Maruti Suzuki; compare Ajanta Pharma with Sun Pharma; compare TCS with Eclerx. On every occasion (Auto,Pharma, IT, banking almost from all sector) you will find the small cap stock outperforming the large cap stocks. Here the only condition is that the comparison should be between “quality small cap” versus “quality large cap”. You can’t take consideration of poor quality small cap stock like IVRCL, Rei Agro etc.
Investing in large cap stocks makes sense if you can’t devote enough time to research the market or if you don’t have proper advisor to guide you. Otherwise, small cap investing is much more rewarding than large cap across any market cycle.
Apart from capital appreciation, various investors go for large cap due to better dividend yield. Now let’s have a look on the “dividend yield” portion-
Dividend yield – Quality small caps do well
Once one of my clients mentioned that he wanted to prepare an equity portfolio for his retirement needs that should consist of large cap stocks as those stocks offer better dividend yield. During our telephonic conversation, I failed to convince him that even mid cap and small cap stocks can also offer better dividend yield. I know it is hard to believe, so let’s check few real life examples-
During December-2012, I had recommended a small cap Pharma stock named Ajanta Pharma at Rs-250. The stock was not in the radar of mutual fund managers and was quite unknown at that time. Backed by strong fundamentals and better future prospects, the stock generated more than 6 times (550%) return within the next 2 years (CMP -1745). Apart from huge capital appreciation, let’s have a look on the dividend yield part. During July-2014, the company declared 200% dividend on the face value of Rs-5. Thus, it translates into dividend of Rs-10 per share. Now anyone invested during December-2012 would have received Rs-10 dividend on their investment of Rs-250. Dividend yield of 4% is not bad while considering 4% annual interest on savings bank account. So, you have 550% capital appreciation and 4% dividend yield from your investment within 2 years. I can bet, any large cap stock can’t meet this combination of 550% capital appreciation and 4% dividend yield within 2 years.
Let’s have a look from different angle-
You may think that Ajanta Pharma is an exception, so let’s have a look on few more stocks. Avanti Feeds, a small cap unknown company from aquaculture sector was trading around Rs-130-200 during June- September last year (in 2013). At the time of writing this article, the stock is trading around Rs-1400 and has offered a dividend of Rs-15 per share. If you had invested in Avanti Feeds at Rs-200, then you would have gained 7.5% dividend yield (on your purchase rate) and a whopping 7 times capital appreciation within just 1 year – impossible for any large cap stocks. Similarly, investment in Page Industries (small cap stock from apparel sector) during July-August, 2012 generated 20% dividend yield and 100% capital appreciation within next 2 years – again impossible for any large cap stocks. Moreover, Page Industries has a track record of offering dividend 4 times in a year! The list has many more in it. There are at least 30-40 small cap and mid cap stocks that can consistently outperform any large cap stocks in the form of dividend yield and capital appreciation. So, who told you that only large cap stocks offer steady cash flow in the form of dividend?
The problem is that while calculating dividend yield, we consider the current market rate. Theoretically, it is absolutely fine to compare dividend per share with current stock price to calculate dividend yield, but from an investor’s perspective isn’t it logical to compare dividend with his purchase rate? It makes more sense. Suppose, few years back, you had invested in a stock at Rs-200. Today, the stock price is at Rs-100 and the company is offering dividend of Rs-4 per share. So, apparently it looks that as per current market rate of Rs-100, they are offering 4% dividend yield, but what about your original purchase rate. You had purchased it at Rs-200 and getting Rs-4 dividend, so doesn’t it makes a 2% dividend yield for you? Statistically, 4% dividend yield is all right but from investor’s point of view it is not. This is another reason for the wide-spread misconception – “Large cap stocks always offer better dividend yield than small caps.”
From the above discussion, now it is clear that if you can select quality stocks from mid cap and small cap space then it can easily outperform large cap stocks on every front – be it capital appreciation or dividend yield or steady cash flow. Moreover, quality small caps can be less volatile than the large cap stocks. During market crash or economic slowdown, large cap stocks may fall more than the “quality small caps”. The only thing that you need to keep in your mind is “quality small caps”. Not all small caps and mid caps will yield the same result. If you arbitrarily select any small cap then the maximum probability is to get negative return. From the entire universe of small cap stocks, only 1%-2% may have all the characteristics of “quality small caps”. So, the story is all about stock selection.
Important Notification – We at Paul Asset, recommend high quality, high conviction fundamentally strong small cap or mid cap stocks on every month.Check out what our existing clients are saying. Click here to check our detailed service offering.
Few months back, I had noticed a portfolio allocation pyramid in a financial portal. Through the pyramid, they suggested that large cap stocks should comprise 50%-60%, mid cap should 25%-30% and small cap should 5%-10% of an equity portfolio. As per our view one should not divide portfolio stocks based on market cap. Today’s large cap can become tomorrow’s small cap (Example –Suzlon) and vice-versa.Your portfolio should only consists of “quality stocks”. It is absolutely fine even if you have 100% exposure in “quality mid cap and small cap stocks”.
Misconceptions regarding small cap investing is rooted so deep that many investors may not accept the fact that even small caps and mid caps can offer more safety, better dividend yield and obviously better return than large cap stocks.
Comment section is open. Existing members of ours or new member/guest anyone can share your views regarding the same.