Five key things to watch out before investing in smallcap stocks

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Second rung stocks have outpaced the domestic benchmark equity indices in 2021 so far. While the BSE MidCap index and SmallCap index have gained 14% and 22% respectively, year-to-date, the BSE Sensex has advanced just 2% during the same period.

Majesco stock, which rallied 367%, emerged as the top gainer among the broader indices. The scrip has moved to Rs 72.15 from Rs 15.45 on December 31 last year. Adani Total Gas, Magma Fincorp, Adani Enterprises, Adani Transmission, Hindustan Copper and Balaji Amines have also gained over 140% YTD.

Axis Securities believes that going ahead the equity market is likely to be the best performing asset class for the next 1-2 years. While the second wave has posed significant short-term challenges, the structural trend continues to remain positive. If you are looking for few investment options in the midcap and smallcap space, Angel Broking in a blog listed few points which you should keep in mind while investing.

1) Bottom-up stock selection: Midcap and smallcap stocks are extremely heterogeneous. They are less vulnerable to economic cycles and hence a bottom-up stock selection approach works better for them.

2) Working capital management: Most small companies tend to take a hit on the working capital management front. Either they are able to get proper credit terms from suppliers and vendors or they are not able to get adequate bank financing. Hence focus on working capital is a must.

3) Management stability: Investing in broader markets is an art that is perfected over a period of time. Investors should avoid smallcaps and midcaps where the core management team has been going through consistent churn. One should also stay cautious on a string of senior level exits in a short span of time.

4) Performance in bad times: Investors should also zero in on how the company has done in bad times. A small that can do well in bad times will also have the ability to leverage its core strengths in good times.

5) Margins and liquidity: Investors should look at efficiency margins and profitability margins and also look at the trend over 3-4 years. Consistency and the ability to improve is what will determine the future trajectory of the stock price. One should also focus on stock liquidity in the market. An investor never wants to get stuck into a stock that will be difficult to liquidate.