ET Intelligence Group: Investor interest in Indian small-cap stocks is likely to remain limited in the near term, as they are seen as relatively unattractive in valuation terms to largecaps unless supported by meaningful earnings upgrades.Investors have been making a strong case for a broad-based rally in 2020 on higher participation from smallcaps that would improve market breadth to sustain the equity momentum from last year.
However, a fall in earnings of smallcaps has eroded their relative valuation allure despite gradually reducing their underperformance against largecaps.The MSCI India Small Cap Index an index designed by the MSCI to measure the performance of the small-cap segment is trading at 20.33 times its one-year forward earnings, a premium of 7.67 per cent to the MSCI India index, a large-cap index, according to Bloomberg data.In the last 10 years, the smallcap index had traded at a 10 per cent discount to the MSCI India index on average and had underperformed the large cap index by 24 per cent over the past three years.
However, this underperformance has gradually reduced from the start of the second half of 2019.The reduction in corporate taxes, announced by the government last year, helped improve the one-year projected earnings per share of the MSCI India index by 3.57 per cent in the past one year.
However, it has been unable to arrest the fall in earnings of small-caps, with the EPS of the MSCI India Small Cap Index falling 2.44 per cent in the same period.This has eroded small caps relative valuation attractiveness against the big stocks.The MSCI India Small Cap Index, which constitutes 14 per cent free float capitalisation of Indian equities and comprises 249 securities, has underperformed even the MSCI Emerging Market Small Cap Index consecutively for the last two calendar years.Besides, the flow of domestic mutual funds into small-cap schemes has also been whittling away.
Inflows averaged at Rs 341 crore over the past two months, compared with Rs 1,002 crore in the previous six months, according to data compiled by ETIG.The assets under management of small-cap funds stood at Rs 48,534 crore at the end of December, accounting for 6.32 per cent of the total equity AUM.