Up to 900% return in 1 year! Smallcaps in a young and vibrant bull market: Shankar Sharma

The S&P BSE Smallcap index touched a fresh record high on Monday, but the rally is far from over as smallcap stocks are in a young and vibrant bull market, Shankar Sharma of First Global said in an interview with CNBC-TV18.

The smallcap index has been on investors’ radar for the past few years. While it has rallied over 40 percent, some of the stocks have risen up to 900 percent during the same period.

Stocks which rose in the S&P BSE Smallcap index include names like Indiabulls Ventures which rose 942 percent, followed by HEG which gained 666 percent, Graphite India (up 484 percent), and Avanti Feeds which soared 365 percent.

Investors get attracted to smallcaps in a high growth environment. And, even though, expectations of sharp growth rebound is not expected due to demonetisation and implementation of the goods & services tax (GST), smallcap stocks will still hog the limelight.

“I had a view of policy that there would be some growth, but not enough to propel the whole basket of largecaps. But, smallcaps don’t need that. Smallcaps need 3-4 percent GDP growth for Rs 100-500 crore company to go to Rs 1,000 crore company,” said Sharma.

“I made a distinction long time back that forget about largecaps and smallcap is the space where one needs to go. But, interestingly after huge outperformance, I don’t think that smallcaps are in a mature bull market,” he said.

Explaining the rationale, Sharma said that smallcaps just took out the high of 2008 three months back. Even though it looks like they have done very well but they have done very well after hitting the bottom.

The real bull market starts when you take out long-term high, which they just did and if they double and triple from here on then we will talk about bull market becomes aged, he explains. Right now it is a young and vibrant bull market in smallcaps.

Sharma prefers to pick stocks which are contra buys. He looks for stocks where there is trouble which could be fixed. “If there is a business problem or a business issue, I like to see if those issues can be fixed or overcome,” he said. Jaguar solved the problem for Tata Motors.

Commenting on the infrastructure space, Sharma said infrastructure companies look interesting but you need to be stock specific.

The only trouble with the infrastructure sector is that companies in this space they don’t have any asset. Therefore the trouble is that there is very little which somebody can recover.

“I had a firm belief that India’s NPA problem is unlikely to go in a hurry because most of the exposure lies in sectors which don’t have many assets to repay. Chose stocks in which you have confidence that debt can be addressed and not by large equity issuances,” said Sharma.

Below is the verbatim transcript of the interview.

Q: Markets have been doing good, we are at all-time highs. This year year-to-date (YTD) the Nifty is up good 24-25 percent. Where are we in this bull phase, is there more leg to go?

A: Yes, definitely I think we would in context of the global situation every market in the world is doing phenomenally well, that we all know. The US markets, Europe, Japan, and emerging markets -- they have had a wobble till last year, till 2016 emerging markets particularly the commodity centric emerging markets basically Brazil, Russia, and to some extent China, they were looking very shaky. However, from February 2016 they bottomed out and from there they have done phenomenally well which is when we actually turned bullish on emerging markets overall; when oil was 27 if you recollect. In that context, India has been doing good and I expect the trend globally in equities and in India to be very strong without any doubt.

Q: What would lead through this global rally and the emerging market rally because a lot of people are believing that this growth is for real in the US market which will probably lift all the tiding boats, is that the view that you share?

A: There is a bit of a difference between the Indian rally and the global rally now. The global rally is based on very strong economic growth revival. This year the world will grow 3.6 percent as per IMF estimates, I mean that is just a blowout set of numbers globally. For the last seven to eight years we have not seen numbers close to that. So the global rally started out based on purely interest rates but now has become actually a rally based on economic momentum.

India is a little bit different in which our rally is not yet based on any earnings growth or any economic growth worth the name. So therefore despite that why is India doing so well stock market wise? The answer to that is very simple that markets run because of two things, one is growth, and second is the price of growth, which means interest rates. In my view, last two or three years is that India is not a growth trade, India is a pure cost of capital trade, that rates were too high.

If you look at India and the rest of the world, other countries have seen their bond yields fall 90-95 percent, even 100 percent, down to 0, while India at 8 percent was way too high. The gap between Indian rates and global rates in the last seven to eight years has become unsustainable. Therefore my call was this gap has to collapse and it has to collapse only one way that Indian rates have to come down and since then we have seen a very substantial cut in interest rates. That is the sole reason why India has done well.

Q: I was reading a recent tweet where you have said that you like to make a lot of money in the so called junk stocks or the mispriced opportunities. The midcap and smallcap has done really well as far as index is concerned, but within that, many of the stocks have been 10x, 20x, 50x. You still think there is a lot of value to be or money to be made in the midcap and smallcap?

A: I got interested in midcaps, rather smallcaps when nobody was interested in them and that was three years back. Everybody was focused on the big headline grabbing large companies and my view was very clear that given what I saw of policy, my view was that there is going to be some growth but not enough growth to propel the whole basket of largecaps to 15-20 percent earnings growth. However, smallcaps don’t need that, smallcaps need very – maybe 3-4 percent GDP growth is good enough for a company of Rs 100-500 crore turnover to go to Rs 1,000 crore. However, for Larsen and Toubro (L&T) you need a far bigger tailwind.

So I made that one very clear distinction in my mind that largecaps, forgot about them, smallcaps is where one needs to go and of course at that time it was not popular. Now everybody talks about it but that time it was a very against the consensus view. However one has been very handsomely rewarded, the data is out there. However, the interesting thing is I don’t think it is a mature bull market in smallcaps.

They have just three months back taken out the highs of 2008. So while it looks like they have done very well, they have done well coming from the bottom. However, they have just taken out what was where they were in 2008. So real bull market starts when you take out a long term high. Long term high has just been taken out. When they double from here, or triple from there, then we will talk about the bull market becoming aged or tired. Right now I think it is a young, vibrant bull market in smallcaps.

Q: I was just looking at past data and the amount of midcap stocks that you have identified which have eventually become largecaps. I think one of your big bet was Tata Motors; it has done phenomenally well in the last many years, it has gone through its own cycle, what is your view there and in the largecaps do you see any opportunity where you think investors can make big money?

A: Again Tata Motors falls in-line with what we look for in companies that any trouble and I have always said this that the only place I will not go where there is trouble is where there is fraud because then you don’t know what you are buying, whether the numbers are right or wrong, that is too much trouble. However, if there is business problem, or there is some issue, I like to look at those whether they can be fixed, whether they can be overcome. In Tata Motors, the Jaguar part solved that problem.

In steel in 2016 when everybody was saying steel – commodities were at junk, we got interested and look at steel stocks in the last couple of years, they have been just several times. Same with other non-ferrous companies, take a Vedanta or something, they have done phenomenally well. So we liked all of them when people hated all of them. That is the way we look at investing. So we don’t have a view on greatness or goodness, everything has got a price and that price I think the risk reward is good, I am going out and it is my money, I have a right to invest where I want to invest.

Q: What about infrastructure, because that is again a hated space, not many people like that space still yet. You think there are a lot of opportunities to make money in infrastructure space?

A: Sure, because again it is a problematic space. I am not making a case for infrastructure overall, but you have to pick and choose. The trouble in infrastructure is that you don’t have any assets; infrastructure companies don’t have assets, they have only contracts and projects. So therefore in trouble there is very little that somebody can recover which is why the banks – I have always believed that the Indian NPA problem is not going to go away quickly because most of the exposure lies in sectors where actually there are not enough assets to repay.

So many people took bets on PSU banks and we have seen how that has played out. However, my view was that don’t even touch it, because there is no recovery coming out of those. So infrastructure, yes, carefully picked and particularly picked where you can see that the debt can be addressed, not via large equity issuances or a debt for equity swap, because that won’t help. Look for places where large amounts of receivables are going to be recovered by way of arbitration or some assets, some project can be sold to settle with the banks. Otherwise infrastructure is still problematic.

Q: The other big problem sector for India for the last many years has been telecom. Everyone knows you have made one big bet in the very small telecom stock. With the sign of consolidation that we are seeing, do you think now telecom as a sector is out of the woods and will probably deliver?

A: We have been negative on telecom 2007.

Q: You rightly pointed out that time that there are some 10 companies fighting out for growth and that is never a good sign.

A: Never a good sign.

Q: But now only two or three players to survive.

A: Yes, but the growth is behind us now. Now it is that you have already reached a high degree of saturation.

Q: Data won’t be a big growth for telecom companies?

A: It is my belief that price understanding in the sector is still several quarters away if at all it is. It is not to say it can’t happen, we have seen price understanding happen in cement, we have seen price understanding happen in airlines. I don’t want to call it cartelisation, but people get together in a room and they talk about let us not kill each other. I think that is still a while down the road. I don’t think it is like happening right away. However, some day it will happen, then we will get interested, we will see.

Q: The other space which if I understand you correctly, you don’t like is where there is over-crowdedness or there is too much of weightage in the index or in a particular sector which becomes too much of an overweight. Banking right now seems to be that space, private banks, NBFCs, housing finance companies, small banks, all seems to be the favourite of the investors right now, you think there is a bit of a risk there?

A: As a business, I don’t like businesses that leverage themselves 15-20 times over to do lending. So within that we have liked HDFC Bank, and a few other banks, IndusInd Bank and all that, they have done very well. However, as a broad category of businesses, we are not big fan of finance related businesses. However we like non-balance sheet intensive businesses like AMCs or insurance, etc. I think those areas one should really focus on. They are set for a big bull market.

Q: From a market point of view, we are at above 10,000 on the Nifty. If we compound at 15 percent CAGR over the next five years, Nifty can double, is that a fair assumption?

A: I think that is a fair assumption give or take a little bit of compounding here or there but I think smallcaps will compound a lot more than that. However, I must caution that it is difficult area to invest in because we know how much trouble we have to go through to identify a single stock, it takes many months of work. So for a small investor it is not possible.

So buy some good funds, there are many good smallcap funds out there and very well managed funds, but definitely expose yourself to smallcaps rather than largecaps within the ambit of equities. Overall I think equities are the place to be in incrementally for the next several years in India.