15 mid and small-cap stocks you can add to your portfolio

Equity investment in mid and small-cap stocks is about to change dramatically in India over the next few years, thanks to market regulator Securities and Exchange Board of India (SEBI). Last week, SEBI came out with a circular that will force mutual fund managers to change the relative weightage of small-cap, mid-cap and large-cap stocks in their multi-cap funds.

Market analysts expect a large inflow of fresh money to smaller counters in the market as fund managers re-balance their portfolio to meet the new mandate of the regulator.

The last few years saw a mini boom in the launch of multi-cap equity mutual funds as fund houses tried to cash-on the investors’ interest in second and third tier and smaller companies. These multi-cap funds were launched with a mandate to provide exposure to fast-growing small and lesser known companies to equity investors. In practice however, most fund managers of multi-cap funds invested the bulk of their corpus in large-cap stocks with exposure to small-cap being as low as 10 percent. In comparison, exposure to large-cap stocks was in excess of 80 percent in most of the schemes.

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As per this classification, 95 percent of all listed companies fall in the small-cap categories. So fund managers are spoilt for choice if they want to pick and invest in this space.

Most fund managers, however, stick to the most widely-tracked and visible names in the large and the mid-cap space. The industry regulator now wants to take away this flexibility from fund managers.

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They have full flexibility about the balance 25 percent of the corpus. Till now, there was no individual cap across sectors that provided full investment flexibility to fund managers.  The regulator has also raised the overall equity exposure limit of multi-cap funds to 75 percent from 65 percent at present.

This, analysts believe, could lead to a big churn in the industry and force many funds to sell their large-cap holdings and buy more smaller stocks especially small-cap stocks.  

According to estimates, fund managers may have to make additional investment of upto Rs 35,000 crore in mid and small cap stocks to meet SEBI’s new guidelines. The numbers are based on  multi-cap funds combined AUM of around Rs 1.46 lakh crore currently.

This is expected to fuel a rally in the smaller stocks and many of them could get re-rated, which means an expansion in their valuation ratios such as price to earnings multiple and price to book value.

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But selecting the right investment candidate in this space is not easy given their diversity and lesser news flows about their activity and financial performance. We have made the task easier for you. Here are 15 smaller stocks whose current valuation is attractive compared to their average ratios in the last five-years. They have been chosen from the universe of stocks that are part of BSE Mid-cap and BSE Small-cap index. 

We have only included those stocks that have shown above average revenue and profits growth between FY15 and FY19 and had high return on equity during the period. We have also weeded out companies with high debt and poor balance sheet ratios. In a nutshell, these are companies with reasonable valuations currently and a record of faster and profitable growth. Happy investing.

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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