Saurabh Mukherjee: Why do smallcaps falter before they are in full bloom? Saurabh Mukherjee told 4 reasons

For a smallcap investor, slowly turning his hidden gem into a much-awaited largecap stock and delivering multibagger returns in between is a dream. Famous fund managers citing market data Saurabh Mukherjee It is said that most smallcaps that show early promise falter as they grow up and eventually sink into oblivion.

Data collected by PMS firm marcellus Investment managers show that in the three-year run-up to entering the BSE 500 index, these potential entrants have outperformed the index at a CAGR of 36 per cent, as they move closer to entering the benchmark index. .

“However, this trend completely changes once these stocks enter the index. Unlike their performance pre-entry, new entrants to the BSE 500 average BSE 500 less than 11% per annum in the three years of entry. done,” says Mukherjee, whose firm handles HNIs and institutional funds worth over Rs 11,000 crore.

Team Mukherjee cites four reasons why most companies that enjoyed a great run when they were small, are unable to keep up the momentum once they grow big and enter the BSE 500 index.

1) Accounting/Governance Issues
When it comes to investing in smallcaps, accounting and governance risks are high due to relatively high reliance on promoters and analysts’ coverage and relatively low level of institutional ownership, as a result of which these companies are not subject to extensive due diligence, he said. . As the investigation progresses, new issues emerge.

2) Wrong allocation of capital
Capital allocation tends to be one of the biggest make-or-break events for a company, especially as it grows larger in size and accumulations become larger, Mukherjee said. In most cases, he said, the promoters or those at the helm of the capital allocation decision exhibit behavior that is prejudicial to the interests of minority shareholders. He says that most of the entrants in BSE 500 are unable to maintain their return on capital employed with the increasing size.

3) Succession Planning
Smaller companies typically include a single person at the helm of affairs, but as the company expands, increasing business complexities require a wider group of people, as well as a new generation with leadership responsibility. Requires delegation of key responsibilities as well. Mukherjee said that these HR issues have eventually become the key avenues for the business to grow.

4) Re-rating benefits are dwindling
Once the smallcaps reach a certain size, they move up the valuation band. However, the role of valuation re-rating in share price returns diminishes as the company gets bigger and growth becomes its major driver, he said. Smallcaps often see massive re-ratings before being included in the BSE 500 index as investors start rewarding it on growth prospects, but usually de-ratings due to stable fundamentals.

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