Sebi probing smallcaps a warning bell for microcaps; time to exit: Analysts

Micro-cap stocks are in the line of fire as market regulator Securities and Exchange Board of India (Sebi) is tightening its noose around investment in small-cap stocks.

Given this, analysts suggest investors exit the segment, at least, for the time being.

Independent market analyst, Ambareesh Baliga, for instance, said that regulators have gotten worried on the valuation front, though belated, which could prove to be the last straw on the camel’s back.

“Until recently, corrections in microcaps were seen as a buying opportunity, which proved right as well.

“But when valuations become super expensive, the safety net is non-existent.

“It’s pertinent to control greed and take profits home or cut losses, if any,” he said.

By definition, micro-cap stocks are the ones that are outside the ambit of top 500 companies (in terms of market capitalisation), with their market cap being less than Rs 5,000 crore.

Thus far in the month of March, the Nifty Microcap250 index has declined 7 per cent on the National Stock Exchange (NSE) as against a 1.5 per cent gain in the benchmark Nifty50 index.

The Nifty MidCap and SmallCap indices, meanwhile, are down 0.5 per cent and 3.6 per cent, respectively.

Among stocks, JTL Industries, Inox Wind, Neuland Laboratories, Ranky Infrastructure, MAS Financial Services, Himadri Speciality Chemical, and Jindal Worldwide, have plummeted the most, dropping in the range of 18 per cent to 33.4 per cent on the exchange, ACE Equity data shows.

Sebi’s growing concern

Over the past one year, micro-cap stocks had a dream run on the bourses.

Of the 250 stocks in the Nifty Microcap 250 index, more than 70 stocks zoomed over 100 per cent  (up to 722 per cent) during the period, led by GE T&D, Anand Rathi Wealth, Electrosteel Castings, Inox Wind, and HBL Power Systems.

The trailing 12-month price-to-earnings (P/E) valuations of these stocks have surged up to 256x.

At the index level, the microcap benchmark surged 75 per cent (27.3x) during the period, while the Nifty50 rallied 28.3 per cent (23x P/E).

This stupendous rally has prompted Sebi to take steps to protect investors from the froth in the segment.

On March 11, the regulator said it is open to revising rules that mandates small- and mid-cap funds to invest at least 65 per cent of their assets in such stocks if fund managers find it is ‘restraining risk management’.

Further, chairperson Madhabi Puri Buch said Sebi has observed signs of manipulation at both the trading and issuance levels in the small and midsize enterprise (SME) space.

“There are pockets of froth in the market; some call it a bubble.

“It may not be appropriate to allow that bubble to keep building because, when it bursts, it adversely impacts investors.

“MF trustees should formulate a policy to manage this risk,” she added.

Last month, the market regulator had asked money managers to take a stress-test of small- and mid-cap funds and submit a fortnightly report.

“Small/micro-caps segment is experiencing volatility as investors are turning cautious over valuation concerns.

“Allocation towards these segments is close to an all-time high, and the recent news flows around tightening capital raising requirements has triggered exits from micro caps.

“We expect the volatility to continue in the near-term and recommend limiting exposure to quality names in the segment,” said Anil Rego, founder and fund manager at Right Horizons.

Investors, he added, could partially book profit in small and micro-cap space and invest in flexi-cap categories to aid the overall portfolio performance.

That said, projections of India’s strong economic growth could help smaller companies generate superior returns as and when the sentiment improves, believe analysts.

Nonetheless, they suggest investors do thorough research in the micro-cap segment before investing as they carry higher risk than larger companies.

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