The key is to look for smallcap companies who have stood out in tough times.(Representational) Screening smallcap stocks can be difficult because first of all, there are so many to choose from. There are many factors that need to be considered when screening for potential investment opportunities.
So, if you’re looking to invest in the smallcap space, this is how you should screen for the best smallcap stocks.
# First of all, think long term
A lot of people I talk to, seem to be punting in smallcaps.
But mind you, short-term punting in smallcap stocks is a dangerous game.
The performance of smallcaps is more volatile and unpredictable in the short term than other market segments.
The business of smaller firms is far more uncertain because the cash flows are more difficult to estimate.
Our smallcap guru, Richa Agarwal, frowns on short term investing in smallcaps. She strongly believes smallcaps are the best asset class for long-term wealth creation not for short-term speculation.
According to her approach, you need to do a bottom-up analysis i.e., focus on the business fundamentals, growth prospects, management, and valuations with a time frame of 3 to 5 years .
This approach varies from the mainstream approach, which is more top down, focused on the short-term, and chases stocks which are expected to gain from macro themes.
To make this process easier for you, here are three ready-made screens to find the best smallcap stocks:
# Look beyond smallcaps that the market is aware of
The well-known smallcaps will probably deliver decent returns in the long run…but if you want potentially life-changing profits, you must look elsewhere.
Finding multibaggers from an entire universe is no easy task. That is why you must have some criteria laid out to find hidden gems from the smallcap space.
One way to do this is to focus on companies which have low marketcap or companies which are leaders in the segment they operate in. Basically, they should have an economic moat and some niche products, or services in the offering.
Take the example of Rajratan Wires. The company is into tyre bead manufacturing – a very niche segment.
The company is the only bead wire manufacturer in Thailand (via a wholly owned subsidiary). It has a market share of over 50% in India.
Over the years, the company took huge capacity expansions to drive future growth. The results are there for you to see… Over this time, the country has seen a crash in smallcaps, a deadly pandemic, supply chain shortages, inflation, and even slowdown in the auto sector which is the prime industry the company caters to.
None of this has come in the way of the stock’s performance.That’s the beauty of investing in small-cap stocks, having patience, and the power of long-term investing.Well known smallcaps of today started from scratch when they were trading at a low share price and a low market cap. # Identify a strong business with good management “The key to investing is … determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.” The roadmap to making it big with smallcap stocks begins when you select a company with a strong economic moat and a good quality management team heading it.In investing, a moat refers to a business’s ability to maintain its competitive advantage over its peers to protect market share and ensure sustained profits. This is what allows a business to earn high returns on capital over time.Moats could come from having a cost advantage (being the lowest cost producer), brands (such as Asian Paints, Castrol), exclusive licensing or patents (Astral Polytechnik and its tie up with Lubrizol a few years ago), network effects (as in the case of Alphabet), higher switching costs (like in case of private banks).Think about Coca Cola, Amex, and Wells Fargo. These companies have been around for decades.There are businesses that compete with them. Yet these companies have not just survived but expanded market share multifold.Now that we saw how to initially build a list of fundamentally strong smallcap stocks, here are some other screening criterions that could help you filter out the needle from the haystack. # Check if the smallcap is shareholder friendly firm You need to see if the smallcap firm under question has a history of regular payouts.Dividends form an important part of your investing journey. They provide a steady stream of income and help you build wealth […]
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