Largecap stocks won’t offer safe and steady return always

By     |     September 13, 2014     |     31 Comments

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.

  1.  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.
  2. 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%).
  3. Moving forward to the year 2012 when Sensex generated 30% return. During the same period CUB generated around 52% while SBI generated 35% return.
  4. Similar trend continued in 2013. Current year (2014) is also no exception.
Period 2010 2011 2012
Sensex Return 14.20% -25% 30%
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-

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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?

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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.

 

By     |     September 13, 2014     |     31 Comments

31 comments on “Largecap stocks won’t offer safe and steady return always

  1. Regarding the portfolio allocation pyramid of equitymaster, I was partly a victim of that pyramid that my average return was around less than 15% over 5 years. I got to see above 30% “average” return and developed convention after seeing couple of ace stock pickers like Paul Asset that getting 25% cagr or above is indeed possible and achievable over long term of bull and bear phases.

  2. That portfolio allocation pyramid is to ensure that they get subscription to 3 separate products. Client will only get average or below average returns. Beating the index is not the goal.. Getting a certain cagr return (averaged over long term as stock market is volatile and nonlinear) is, for an investor of money. An advisory has to guarantee a minimum cagr return collectively for the portfolio of recommendations. Look for this assurance that reflects the conviction and confidence in such investment recommendations while choosing your investment advisor/guide/teacher.

  3. Your views on investment based on strong fundamental companies is highly appreciable so that investors do not lose money.

  4. very nicely explained… but I have seen many analyst and brokerage companies provides high yield dividend stock to pick… I would like to know why do then prefer to invest dividend paying stock rather than fail to check the capital appreciation on the stock. or is that if there is high dividend yield means high capital appreciation too?

    what is the liquidity point of view for large and small cap? does large cap give more safety there?

  5. liquidity is the fear factor for many (may be for nowise) investors… but take example of kingfisher even co. is about to scrap, share is still trading how is that so

    1. Again, liquidity fear will come from poor quality stocks be it large or small cap….Today a quality small cap stock may have less liquidity but as the time aheads, more market participants recognize that quality small cap,liquidity increases and thus quality small cap generates multi-fold return…

  6. You are right Prasenjit! I am holding largecaps (Infosys, TechM) for past 1 year and the returns is only 30% where as the small/mid caps provided up to 500% returns (cera, wimplast, vst tillers, dhanuka). I bough all these as they are “quality stocks”.. but largecaps have sluggish profit reflection.

  7. A vital secret to picking a multibagger is its illiquidity. As the stock gets discovered or rediscovered, liquidity goes up. Even highly liquid stocks can come down by 20% in a given day if something goes bad (it is just demand supply equation). A less discovered stock could come down further till it finds enough buyers. If we pick a high quality business, liquidity does not matter; when we decide to sell, liquidity levels would be high by then. It is OK to forego a little if a lot is made on that stock.

  8. Dividend yield provides downside protection. If a stock comes down, its dividend yield goes up and new buyers would soon come in. Example vst industries just after 2014 budget day. If your goal is capital protection, go for pure dividend yield stocks. If your goal is capital appreciation, go for high growth stocks. If your goal is capital appreciation with downside protection, go for high growth stocks with dividend (like Page in Prasenjit’s writeup; due to growth, dividend yield at purchase price becomes significant as years go by, along with further capital appreciation). As Prasenjit said in his article, key is to pick high quality stocks. Don’t feel bad if you have to miss lot of money making opportunities (these days all stocks are multibagger). If your long term goal is wealth creation, stick to high quality stocks, and more importantly high quality trusted advisors like Paul Asset.

  9. Infosys once upon a time was 30% compounder. Now it is struggling to get back its growth (it is now below industry average while in yesteryears, it set the industry trend). It would soon become a dividend yielding stock if management can’t plough back the profit for further growth and decides to hike dividend. If you keep waiting in such large caps, your average cagr would come down. So always evaluate your initial investment rationale (at buy) on a given company if it is still valid and if not found OK, sell immediately. Don’t invent a new rationale to stick with that company as that rationale would not be sound mostly.

  10. What about disclosure levels where large cap companies may disclose more or even if they don’t disclose an event, impact may be fractional (but depends on nature of event though). In small caps, impact would be very high. Additionally management of large caps would have more frequent analyst meet and press meets in addition to quarterlies. Mgmt of small caps may not be willing to meet analyst or answer their queries.

  11. Dear Mr. Prasenjit , I am not fully convinced with your argument that small and mid cap stocks give better returns always . Take the examples of Sun Pharma aand ITC . From 2008 January to 2014 January ,these two stocks gave 200% plus returns (Sun Pharma 400% plus ) .They set an envious example of stability with exceptional profitability in a long bear phase which no other company in the world perhaps surpassed yet .

    However, I am fully agreed to you on the point that Stock Guru like you has successfully proved it again and again that your insight and superb quality of exploring those hidden gems of mid caps and small caps like Can Fin Homes ,Caplin Point , Suprajit Engg etc convinced that how a quality midcap or a small cap can make miracles !

    Thank you once again for bestowing more faith and trust on you ! We will expect more small cap recommendations from you in the coming days !!!

    1. Even against 400%+ return of Sun Pharma, small cap peers Ajanta Pharma generated more than 5000%+ (100 times) return during your above mentioned period.Similarly against 200%+ return of ITC, Page Industries (and many more) generated better return during the prolonged bear period.

  12. Dear Mr. Prasenjit kumar paul, I am taking your stock recommendation service from April 2014 & I am more than happy & wanted to endorse you for your quality work but I did not want my full name to be displayed,since I am employed in some organization & dont want to give any clue because it can hamper my Job. Thus I am commenting from visitors column. I was in huge loss before taking your service. I remember, on 4th April when I suffered a loss of around 7000 INR in single day because of the “Trial Call” given by so called well known Stock analysis firm “HBJ Capital”. I was very sad & was searching on google by typing “Honest & good Stock analysis Companies”. I eventually clicked for next page & I found a statement ” You can not suffer overall loss by following my all recommendations”. I read that & read many other articles like “Dont sell Yes Bank, o/w u will repent later” & many more. It was a turning point for me. I suscribed your 4 month trial service & within that time period I recovered around 36000 INR(30% of my overall loss120000 INR). Now I just want to say that what you are offering is simply awesome & I think in the terms of quality stocks what you are recommending, not a single stock recommending firm in India can beat you. You had recently said that SENSEX will touch 27000 mark before December 2014 & now the result is in front of us. I have also subscribed “Equity master Research’s” hidden tressure service but your stocks e.g. CAPPL, CANFINHOMES, etc are giving far better returns than those.

  13. Dear Prasenjit,

    I do agree with you on this count. It is the quality of the stock that matter rather than large cap or mid or small cap. Any quality stock will give you returns above average. Market capitalization shall not be the yard stick.
    But the point remains is how to identify them. Every body may not have the expertise or access to all relevant information about a particular stock. one may not have enough time as well to study all them.
    Second point is, there are many rumors in the market, positive and negative about any stock, which to believe and which not to, is the vital question.
    I think for all these you are providing excellent advice. It has not been very long time, I am with you, but I feel your stock tips are well researched.

    Thank you and wish you all the best. I intend to have a long time association with you.

    1. I do agree it is difficult and huge time consuming process to select quality stocks and this is why we are here to offer tension-free profitable investment journey for our clients so that they can easily concentrate to the full time job…

  14. Hi Paul,
    This article clearly bring out the fact that a small cap can also have steady returns, safety and growth potential. Making a blanket statement about all small caps or all large caps will not be correct. There are several variations, exceptions and niche stocks around.
    There is another group which believes that small/mid-cap should give better returns than large-cap. Ultimately the choice of stock matters, whether its small, mid or large. And this is also based on past performance, valuation, and future prospects.

    Your small/mid-cap recommendations are based on thorough analysis and assessment of future prospects. So its the careful selection and analysis of these stocks that increases the success rate. I just wanted to emphasize that for any stock (big/small) one has to do through research or take professional help before investing.

  15. Hi prasenjit,

    I am one of your new members. I am looking forward to learn from you build wealth over a period of time.

    The article was very interesting. I have one request. Could you also compare the index with the small and mid cap index during the period we have compared sbi and cub and also ajanta ans sun pharma.

    The purpose is not to prove anyone right or wrong. Just to see how index have performed vis a vis each other and then see if the movement was helped because of better performance of all mid caps or even if markets are not doing well a good quality large cap or small cap also help in limiting the downside.

    Thanks
    Rahul

    1. Index comparison will provide opposite result because out of 500 small cap stocks that constitute small cap index, only 10-20 stocks are good quality stocks…So obviously, small cap index will underperform..Simple reason, smallcap index itself is filled with poor quality junk stocks…So, the point of the article is if you have the ability to select quality small cap or mid cap stocks then it will outperform the best quality large cap stocks like TCS, Sun Pharma, ITC etc across any market situation…

  16. Dear Mr. Paul,
    I agree with your argument on quality stocks.
    Normally how the stocks are recognized as quality stocks is based on past performance, Management Commitment and transparency, and other several indicators. These indicators are publicly accessible for large companies and because of the size and sheer momentum the Large caps are recognized as quality stocks. Hope you would agree that there would be more quality large cap stocks than quality small cap stocks (as a ratio). This makes the market to recognize the large cap stocks as quality stocks with ease. Small caps are viewed with doubt. Naturally the quality small caps will have large growth opportunities against till they become large cap. However, what I am reading on the comments section is that you are there to take care of identifying true quality small cap stocks.
    I am new to your portal. Seeing all the good comments I opted for 4 month trial period. Upon good experience I shall be a long time associate with PaulAsset programs.
    Thanks
    Satya V M

  17. After seeing all the above returns it seems in coming future returns will be over as all companies will already by super saturated.

  18. Dear Prasenjit,

    I am a very very new user of your website and still on 4 month trial, but I am already very much convinced with your stock picks even though I am yet to receive my returns as this is just 10th day may be, but I have gone through most of your articles and reasoning and I find myself extremely lucky to get in touch with you.
    you and your work desrves lot of appreciations and I am without any doubt will recommend your work to my family and friends, this is what I can do for you at the moment “word of mouth appreciation”.

    Thanks
    harshit solanki
    a satisfied client.

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