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Should investors bet on small cap stocks in 2014?
With intelligent stock selection and risk filters, some small cap stocks can add huge value to the portfolio.The year 2013 has been a disappointing one for small cap stocks. The BSE Small cap index witnessed a decline of 12.1% while the Sensex gained 8.1%. The overall weak sentiments and challenging macro-economic scenario have unfairly penalized some of the good small cap stocks. But knowing the inherent risks that are associated with small cap stocks, one can hardly blame the investors for shying away from small cap stocks. Going ahead, the year 2014 is unlikely to offer much relief as far as macroeconomic prospects are concerned. Rupee volatility, rising inflation, slowdown in the demand, volatile commodity prices, fuel shortage and regulatory bottlenecks are some of the issues that are unlikely to fade away. Such issues are likely to impact small cap stocks more than the large caps.
But does it mean that investors should shy away from investing in small caps?
Small cap stocks are perceived to have some limitations such as low liquidity, limited track record, higher borrowing costs, weak corporate governance, less transparency and less resilience to weak economic cycles as compared to their large cap counterparts. But the silver lining is that because of ove r generalization of such risks, small cap stocks are not widely tracked. As such, some strong players in small cap segment are likely to be available at attractive valuations. With proper stock selection and minimizing downside risks, chances are that real value can be unlocked over a period of time in such stocks. We will here discuss some of the basic checks or filters that when followed can help you avoid exposing yourself to unreasonable risks while including small caps in the portfolio. First of all, avoid the company with high debt exposure and poor interest coverage ratios. Even if such companies seem to manage well at some particular time, they remain quite vulnerable. High debt or payment issues are some of the most common reasons that trigger a downfall. Further, the quality of management is highly crucial in determining the future of a business. More so in case of small caps we believe. Hence, give due importance to management practices, corporate governance, past track record of the company and promoters while doing stock analysis. A high share pledging is also a warning signal and reasons and terms for pledging should be investigated in detail.