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Are Small-cap & Mid-Cap stocks the correct way to multiply your wealth?

17 June, 2019

After a year full of bloodshed in the small-cap and mid-cap stocks the first quarter of 2019 has given the investors a sigh of relief by providing a significant upside rally. Many scripts have seen a double digit percentile increase in their price levels and the overall sentiment seems to be shifting in the favor of the bulls. Retail investors are constantly increasing their investments in the small and mid-size companies, which leads us to think if that is the best way to multiply wealth or is their more to it?

Small Cap

When you buy shares of companies like HDFC or HUL which have market capitalizations of lacks of crores it’s difficult to expect them to give multibagger returns. HDFC has a market capitalization of around 3.4 lac crores, in order to give you a 10x return on your investment the market capitalization of HDFC has to increase to 34 lac crores, which is close to impossible to be honest considering the current growth rate of India.

Now forget HDFC and concentrate on a small firm like TATA Elxsi which has a market capitalization of 6000 crores, now when you think about it in order to give you a 10x return on your investment Tata Elxsi has to increase its market capitalization to INR 60,000 crores in an industry worth more than $350 billion.

Seems to be more probable than HDFC to give you a 10x right? This is the point I want to highlight in this blog, big companies like HDFC and others will grow and grow at good rates but the chances of gaining multibagger returns are always higher in companies with smaller sizes as it is easy for them to expand when compared to giants like HDFC and HUL.

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

-- Warren Buffett (Trades, Portfolio)

This statement from the world’s most successful investor signifies the importance of size from the context of the investing amount, when you consider it from the point of the market capitalization of companies it makes the same sense that the smaller the firm the higher the growth.

The point I’m trying to make is that when an investor is looking to gain an alpha return from the market he/she should have some amount of smaller size companies in his/her portfolio, this will increase the level of risk no doubt but will also increase the chances of the portfolio giving a higher return. HDFC is a great stock and is there in most portfolios across India but buying only companies like HDFC and TCS etc. will lead to average or nominal returns rather than that extra 6-7% you aim for.