Source: Zhitong Finance

Despite warnings from securities regulators about a potential bubble, India's small cap slump this month was called a buying opportunity by some investors.

Small-cap stocks are seen as the main beneficiaries of the South Asian country's economic growth of more than 8%. After experiencing a sell-off since February 27, the Nifty Smallcap 250 Index (Nifty Smallcap 250 Index) fell by nearly 10%, losing more than 80 billion US dollars in market value in less than two weeks. Earlier, the Securities and Exchange Commission of India directed mutual funds to take measures to protect investors from speculative bubbles in small and medium stocks.

Since March of last year, the market value of this small-cap index has increased by more than 230 billion US dollars, driven by strong earnings and the continuous influx of Indian retail investors. Although valuations are still high, historically conscious buyers say turbulence like the current one is common in bull markets and often pushes investors to switch to high-quality assets.

“There is no doubt that this is an opportunity to acquire a high-quality, well-managed company at a more attractive price,” said Mike Sell, head of global emerging market equities at Alequity Investment Management Ltd. (Alequity Investment Management Ltd.). “There has been no change in fundamentals, and recent corporate reviews are likely to paint a stronger picture than people generally believe.”

Morgan Stanley said earlier this week that India's current economic expansion is similar to the boom period around 2005, when the average growth rate was over 8%. During that period, a small-cap index managed by BSE Ltd. soared by more than 1,200%, during which there were several short rounds of correction.

Since March 2020, the index has experienced two pullback adjustments, 27% and 14%, respectively, but each time showed a strong rebound over the next 6 to 12 months.

“This reshuffle is definitely welcome,” said Deven Choksey, managing director of DrChoksey FinServ Pvt. in Mumbai. “Investors won't mind this pullback.”

What is certain is that although the valuation has declined, it is still at a high level. The expected 1-year price-earnings ratio of this small-cap index is close to 21 times, while the 5-year average price-earnings ratio is 18 times. This prompted some strategists, including Goldman Sachs Group, to suggest turning to India's largest companies.

Goldman Sachs said in a Friday report that small-cap stocks “seem to be full of domestic investors and have reached a multi-year high.” “We continue to lean towards large cap stocks and expect a further shift to quality stocks this year.”

Viewers say that the blowout returns for small and medium-sized enterprises stem from strong growth in corporate profits in recent years. The data shows that since 2022, the earnings of the constituent stocks of the NSE small cap index have more than doubled, exceeding the 40% increase in the same period of the index.

As the stock market continued to decline this week, domestic and foreign funds bought one after another. Local capital was plentiful, injecting a record $1.1 billion into the stock market on Wednesday, while the SME index experienced the worst sell-off in more than two years.

Andrei Stetsenko, LP partner and portfolio manager at Farley Capital in New York, said: “The kind of volatility we are seeing this week presents an excellent opportunity for investors.” “I wouldn't be surprised if other foreign funds that invest in Indian small and medium caps have become significant net buyers in recent days, like my company.”