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Business News/ Markets / Stock Markets/  Foreign investment surge fuels spectacular rally in India’s smallcaps amid bubble alerts

Foreign investment surge fuels spectacular rally in India’s smallcaps amid bubble alerts

Foreign portfolio investors raised investments in smallcaps in FY24, driving a surge in the BSE Smallcap index
  • Small-cap companies such as Suzlon Energy and PNB Housing saw robust increases in FPI holdings, contributing to impressive returns
  • The BSE SmallCap Index delivered a return of 60% in FY24, significantly outperforming the Sensex, which returned 24.8%. (Image: Pixabay)Premium
    The BSE SmallCap Index delivered a return of 60% in FY24, significantly outperforming the Sensex, which returned 24.8%. (Image: Pixabay)

    MUMBAI:Small-cap stocks had a spectacular rally the previous fiscal year, much of it driven by foreign portfolio investors (FPIs) betting on smaller Indian companies even as the surge sparked fears of a bubble caused in part by some murky transactions.

    In the financial year 2023-24 (FY24), about 35% of the total 2.08 trillion of FPI equity investments in India were channeled into the top 100 companies of the BSE Smallcap index, totalling 71,631 crore and making up 70% of the overall investment into smallcaps, according to BSE shareholding data analysed by Mint.

    Read | Mutual funds go on a shopping spree, pumping $35 billion into top companies

    This influx of investments contributed to both the Nifty Smallcap 250 and the BSE SmallCap index, which comprises 946 companies, outpacing returns from the benchmark Nifty and Sensex indices last year.



    And while the shareholding data for the first quarter of the current fiscal won't be available before 30 June, the BSE SmallCap has already outperformed the Sensex by over 6% since 1 April 2024, with a return of 9.6%, compared to Sensex returns of 3.6%.

    However, the rapid rise has not gone unnoticed by regulators. In March, Madhabi Puri Buch, chair of the Securities and Exchange Board of India, warned of “pockets of froth" in the overheated small-cap and mid-cap markets.

    Mint previously reported (here, here, and here) about the potential involvement of Dubai-based hawala operator Hari Shankar Tibrewala in funnelling illegal proceeds from the Mahadev online betting scandal into Indian small-cap stocks.

    Nevertheless, the surge of foreign investors into India’s small-cap market has provided a semblance of stability.

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    “FPIs could continue to invest in fundamentally sound small caps which are reasonably valued," said SK Joshi, executive director at Khambatta Securities. “If the market on the whole pulls back, it might be a good opportunity to invest in quality small caps for the long-term investor."

    Similarly, Kranthi Bathini, director of equity strategy at Wealth Mills Securities, highlighted the importance of a discerning approach to small-cap investments, underscoring the need to assess individual stocks based on their specific merits.

    “While some fund managers will invest in small caps, a one-size-fits-all approach won't work. Certain pockets of the small cap market show signs of frothiness with stretched valuations. However, other pockets present interesting opportunities with clear earnings visibility. We need to analyse these stocks on an individual basis," Bathini said.

    Investments: sectors and companies

    The FPI surge into small-cap stocks in FY24 underscores a steady rise from there years earlier, when only 10% of FPIs' equity investments targeted small-cap companies.

    FPI investments into the top 100 small-cap companies rose 54% in FY22, 27% in FY23, and 25% in FY24. Despite FPIs being net sellers in the broader equity markets during FY22 and FY23, with outflows of 1.4 trillion and 37,632 crore, the top 100 smallcaps saw net FPI buying of 44,913 crore and 57,044 crore, respectively.

    For this analysis, Mint chose the top 100 companies from the BSE SmallCap index.

    In contrast, the picture for midcaps is more volatile. While FPI investments in the BSE MidCap index reached 98,320 crore in FY24, this represents a 10.5% decline compared to FY23. Note that midcap investments surged 203% in FY23 compared to FY22, followed by a 17.3% year-on-year decline in FY22.

    In FY24, within the small-cap segment, FPIs showed a distinct preference for stocks in banking and financials (28%), capital goods (16%), information technology (11.3%), and consumer durables (8%).

    Five companies—Suzlon Energy, PNB Housing Finance, Coforge, Blue Star, and Computer Age Management Services—received 15,700 crore, making up 22% of the total FPI investment in the BSE Smallcap in FY24.

    Suzlon Energy emerged as the leader in attracting foreign investment during FY24. Foreign institutional investors (FIIs) significantly increased their stake in the company, jumping from 13.4% in FY23 to 23.6% in FY24, translating to an investment of 4,246 crore and a substantial rise of 10.25 percentage points in their holdings.

    Other notable FII holding increases include PNB Housing, where foreign investor holdings climbed from 56.7% to 58%, representing an additional investment of 3,662 crore.

    In Coforge, FII stake surged from 26.3% to 35.8%, valued at 3,215 crore. In Blue Star, FII stake witnessed a significant rise from 12.1% to 17.7%, valued at 2,260.6 crore. In CAMS Services, FII stake climbed from 36.1% to 54.8%, worth 2,315 crore, according to an analysis by Mint of data from the Capitaline database.

    Suzlon Energy has the highest price-to-earnings (P/E) ratio of 96 compared to the lowest earnings per-share (EPS) of 0.19, suggesting investors anticipate substantial future earnings growth. Blue Star follows a similar pattern, boasting a high P/E ratio (75) with a low EPS (7.77). PNB Housing strikes a different chord with a low P/E ratio (13) relative to its EPS (16.9).

    Finally, Coforge and CAMS Services find a middle ground, balancing P/E ratios around 38 with healthy EPS of 36.2 and 20.9, respectively.

    The BSE SmallCap, Midcap, and LargeCap indexes are currently trading at a trailing P/E of 32.26, 29, and 24.25 times, respectively, compared to their five-year average P/E of 45.60, 32.30, and 25.40 times.

    "In my opinion, the only story in India is the small-cap story. If you want to make money in India, there is simply no other option but to invest in a well-constructed portfolio of smallcaps because the largecaps are not going to give you earth-shattering returns incrementally," said ace investor Shankar Sharma.

    Not only companies, in FY24, domestic small-cap funds also witnessed a significant surge in inflows, attracting 40,188.55 crore. In stark contrast, mid-cap and large-cap funds saw inflows of 22,226 crore and an outflow of 613 crore, respectively.

    This is a notable shift compared to FY22, where inflows favoured mid-cap ( 16,309 crore) and large-cap funds ( 13,518 crore), with small-cap funds receiving 10,115 crore.

    Market outlook

    "Sectors like specialty chemicals, pharmaceuticals, niche manufacturing, and PSUs could offer promising growth prospects in the small-cap space, given their potential for innovation, export opportunities, and capacity expansions," said Atul Parakh, chief executive at online investment and trading firm Bigul.

    The chosen companies have delivered impressive returns to investors in FY2024. Suzlon Energy led the pack with a staggering 411.4% return, followed by Blue Star (85%), PNB Housing (48.2%), Coforge (44.3%), and CAMS Services (43.5%).

    In FY24, the BSE SmallCap index delivered a return of 60%, significantly outperforming the Sensex, which returned 24.8%. This follows a period of mixed performance, with returns of -6% and 34% in FY23 and FY22, respectively, compared to -0.48% and 17% for the Sensex.

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    Mayur Bhalerao
    "Mayur spearheads data-driven reporting on IPOs for Mint. He also covers market trends, and corporate announcements to ensure comprehensive coverage of the financial landscape. Mayur believes in harnessing the power of Bloomberg Terminal and Capital Line to extract and disseminate critical financial data to cross-functional teams within the newsroom and beyond. disseminate critical financial data to cross-functional teams within the newsroom and beyond."
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    Published: 10 Jun 2024, 07:10 AM IST
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