Richa Agrawal, lead smallcap analyst at Equitymaster, is wary of the small and medium enterprises (SME) space. Her key concerns are limited disclosures and lot sizes, which make it difficult to exit in case the business does not turn out as expected.

But for the many cases of gains disappearing into thin air, there are some cases where SME stocks have proved to be in a different league.

Good SME companies have and will continue to migrate to the main board over time, addressing the concerns mentioned above.

For investors with a high risk appetite, a reduction in the lot size (the minimum number of shares that an investor must buy or sell in a single transaction) is also welcome. Exchanges do this every six months.

As such, it isn’t a bad idea to keep a watch list ready. But how should you start building a watch list for potential multibaggers in this space? Richa believes tracking insider action is a good starting point.

For this article, she’s focusing on three companies where the prices at which insiders have bought shares recently is close to the current price.

Essen Specialty Films

Essen Specialty Films is a part of Rajoo Group. With more than three decades of machine manufacturing experience from Rajoo Engineers Ltd, it has become a supplier to many Fortune 500 retailers and original equipment manufacturers (OEMs) across 24 countries.

The company makes customised plastic and home decor products in six key categories: bath area, kitchen & dining, home decor, storage & organisation, fitness & lifestyle, and outdoor & utility.

Its clients include Ikea, Walmart, Kmart, Bed Bath & Beyond, Rusta, Runsven, Kohl's, Kroger, H&M, Home Depot, H&M and Target.

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While Ikea is a major customer, its share of Essen’s sales is down from 95% in FY20 to 35% in FY23. The top five customers contribute to 75% of revenue as of FY23. More than 70% of its revenue comes from exports. The shift in the global supply chains since the pandemic could be an inflection point in the company's journey.

On a revenue base of ₹1.4 billion, operating profit and net profit margin stand at 18% and 10%, respectively. The return on capital employed was 14% in FY24 and the balance sheet is debt-free.

Key risks to watch out for include slowdown risk in the overseas markets, customer concentration, and a potential deterioration of the working capital cycle.

The company’s market cap stands at ₹750 crore and the stock’s trailing PE ratio is 58x – certainly not cheap. But the promoters have been buying the stock from the open market in the past two months, showing confidence in the future prospects. The latest buying was in September, at a price of ₹361.

Vilas Transcore

The company, which has a market cap of ₹900 crore, manufactures and supplies power distribution and transmission components, mainly to manufacturers of transformers and other power equipment.

It has two manufacturing facilities in Gujarat with a capacity of 12,000 million tonnes per annum (MTPA) and added another 24,000 MTPA at the end of September, increasing its capacity threefold.

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Its clients include Voltamp Transformers Limited, Electrotherm India Limited, Atlas Transformers India Limited and Shilchar Technologies Limited. With investments being made in the power transmission sector, the company's products are likely to be in demand.

Revenue in FY24 stood at ₹300 crore, with an 11% operating profit margin. The company is net-debt-free. The return on capital employed stands at 22%, and the stock is trading at 42 times earnings. The latest insider buying took place in August at a price of ₹425.

Harshdeep Hortico

The company makes and supplies planters for indoor and outdoor use. It also sells accessories such as garden hoses and water cans and recently entered the roto moulded outdoor furniture space.

It markets its products in 27 states & union territories and the majority of its revenue comes from Maharashtra. It has two manufacturing facilities and three stores in Delhi, Pune and Andhra Pradesh, apart from distributors. It also sells its products online.

The company has a debt-free balance sheet. On revenue of ₹48 crore in FY24, its operating profit margin and net profit margin stood at 22% and 13.6%, respectively. The return on capital employed is 25%. The business is working-capital-intensive, so this needs to be monitored along with its growth prospects.

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The stock's PE multiple stands at 17x. It has witnessed regular insider buying, the latest being in August at a price of ₹69 a share, close to the current stock price.

As we’ve said before, the SME space is highly risky. That said, these stocks are worth adding to your watch list. Some may migrate to the mainboard, thus addressing liquidity concerns over time.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com

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