Is this the right time to invest in small-cap funds?
As we knew the fact that after the coronavirus impact, all the markets across the globe have tumbled but it couldn’t last for long, even emerging market like India wasn’t the exception. But it hasn’t taken much time to recover, within less than a year the markets have rallied a lot and touched all-time highs. Now maximum people are fumbled that where to invest or which category to choose for investing. Yes, there are multiple answers for it, but one of the worthier answers is the Small-cap category.
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Breakdown of small-cap:
After the pandemic, all the stocks were rallied a lot regardless of fundamentals, the current rally is a price rally because of the liquidity available in the market, once the situation comes to normalcy, then again, these fundamentals will start influencing a lot.
In small-cap index, there is some correlation between Price and Net profit since past 10 years. But if we observe, there is correlation since 2013 onwards and particularly from 2016 to 2018, the rally was very high and Net profit also rallied a lot.
At present, there is a huge gap between the PAT and Price. So, we could expect that the net profit and revenues will grow in long-term but volatility would be there in short-term.
While coming to the valuations point of view, small caps are trading at fair valuations in comparation to the before corona market conditions. The average 3 years (2017-19) PE is 33 and the current PE is 56. If we compare the current price to 2019 earnings, the PE is 22. All of us are thinking that the small-cap is overvalued because it's touched the all-time high. But our comparison with respect to the average 3 years PE (33) and current PE (22) (price/2019earnings) still we have a huge opportunity.
Data source: ACE equity
In the above chart, we can see the correlation between the Price and Net profit of the index. From 2014-2019, the net profit and the price, both were moving upwards simultaneously and from 2019-20, both the Net profit and Price went down. With this analysis we can conclude that there is some correlation.
Some of the important points in small-cap space that influence more after the pandemic are
Government has introduced some policies regarding manufacturing
Due to the Covid impact, companies started saving costs like operational and other costs
Improved cash flow positions.
Decreasing Debt levels
Improved operating profits
Finally to conclude, we have the opportunity in the small cap funds based on the past analysis and Valuations, it is the right time to invest.