Top Small Cap Stocks: How to invest in the best ones?

Best Small cap stocks
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As an investor, it is important for people to invest in better quality stocks as well as other investment vehicles in order to build a proper and well-diversified investment portfolio. While diversifying your investments make sure that you have also included small cap stocks in your portfolio. In this article, we will discuss all the information you will require before investing in small cap stocks and what are the best small cap investment stocks you can choose from in 2022.

Small Cap Stocks : Introduction

In the stock market, the companies that come under the 2 billion market capitalization are considered small cap companies. The differentiating factor for small cap companies in the stock market is that their overall market capitalization is below Rs. 5000 Cr. 

This is a particular type of stock market classification which is dynamic and changes according to the market valuation of the company. The term market valuation refers to the company’s remaining amount of share available in the market.

According to the Securities and Exchange Board of India or SEBI, the companies with the rank of 251 and beyond in terms of market capitalisation would be termed as small cap. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) both have the small cap benchmark index to track the overall performance of the small cap shares in India. The name of this index are BSE small cap Index and Nifty Small cap Index.

Small Cap Companies in India : Quick Guide

As an investor, you should know that every large cap and midcap company was once a small cap company. Once these companies started to sustain their businesses and increase their revenues step by step, they became midcap and large cap organisation.

Although these companies have higher growth potential, they also have a very risky approach. Usually, high risk tolerant and aggressive investors put their money into best small cap shares with the idea of generating higher revenues.

Investing in Small Cap Stocks : What should you know

Financial power

Financial strength of any company is one of the most common criteria for every investor before thinking about investing their money into a company. In general, the financial strength of a small  cap company cannot be compared with a mid cap or a large cap company because the small cap companies cannot match the sales or subscription figure.

Nevertheless, if the companies have a standard cash flow, proper balance sheet, and a minor amount of debt then these small companies will be able to survive the market and do better than the rest of their competitors. 

Therefore, if you are thinking about making an investment then the size of the company may not necessarily matter but it is definitely important to look after the financial growth and stability of the small cap companies in India before choosing to invest in them.

Past performance and growth of small cap companies in India

Before investing in a small cap company in India, it is important to check the past performance of the companies you are investing into. These companies should possess a satisfactory performance record of at least five years. For example, you can look into the company's sales record, profit, CAGR growth record, etc.

If you compare the performance of a small cap company with other companies of the same category, you will be able to find out how well it has performed in the past few years. If a company consistently performs well in the market in comparison to its peers, investors will eventually receive higher returns from the same. As an investor, you should perform your own research and analyze the stocks very carefully before making your investment choice.

Overall size and position of the small cap company in India

Normally, the small cap companies focus on providing a single service or product to their customers. That is why it is important to have knowledge of the entire business market size and the company which is operating it. It is also equally important to know the whereabouts of the company in that specific market.

This entire information will help you gain a broader outlook on the overall position of the company in the current market scenario. Things like entry barriers, niche positioning, etc. can have a significant impact on the overall valuation of the small cap stocks India.

Company’s management quality in small cap companies in india

In order to determine the company’s future growth, every company’s management has a pivotal role. If you are thinking about investing in a small cap company then as an investor, it is important for you to evaluate the current management of the company as well as its history.

Due to inflation in the financial statement and poor governance of the company, a lot of small cap companies went bankrupt. If a company is facing a legal battle, then try to avoid dealing with those companies. In most cases, the small cap stocks get saturated due to regulatory or legal challenges and that is why it is better to avoid these types of companies.

Small Cap Companies in India : Risk, Is there any?

If you are interested in investing in small cap company stocks in India then you also need to be aware of the risks associated with the investment. Here is the potential risk you may have to face while making an investment in small cap companies:

Volatility in small cap stocks

The stock market is always volatile and therefore the stock prices can change over time. In comparison to large cap or mid cap stocks, the small cap stocks are more dynamic. There is not much cash flow when it comes to small cap equities and they are also less established. 

This volatility can make the prices of stock increase and decrease rapidly. If the investor is searching for a steady income stream then it is difficult to achieve the same through small cap stocks.

Usual Time period of investment in small cap stocks

Generally, if you are patient enough you will be easily able to generate returns through investing in small cap companies but this is only applicable if you wait for a long time between the selloff and purchase of the equities. If you are looking for quick cash then investing in a small cap company is not the perfect idea.

Small cap stocks : Additional risk factors 

Normally, the small cap stocks are considered high risk investments because they are mostly not well known among other investors which is the exact opposite of large cap and mid cap companies. Due to the same reason, the equity prices of the small cap companies can change drastically.

Investment returns of small cap stocks

The small cap stocks have the ability to provide you with higher returns than the large cap equities. Nevertheless, you also need to note that the returns you will receive after investing in small cap companies are not consistent at all. Sometimes they may provide you with higher returns simultaneously; they can also underperform within a specific tenure.

Investment cost in small cap stocks

In comparison to the investment cost in large cap and mid cap companies, the overall value of investing in a small cap is significantly less. Yet, as an investor, you will also have to pay other fees such as transaction costs, brokerage fees, etc. Therefore, before making an investment think and make your decision accordingly.

Taxation in small cap stocks

If you are not a resident of India then you may have to buy shares of a small cap company through an Indian broker but you will have to pay capital gain taxes under the Indian tax laws. That is why you also have to consider if investing in equities will incur profit or loss for you while dealing with small cap stocks.

Growth of the small cap companies 

Another way you can evaluate a company as an investor is by looking at how much revenue it generates every year and the amount of money it has in hand. This is how you will be able to find out if the company is financially stable or not. If the small cap company does not have enough money at its disposal, then it is highly likely that it won’t be able to reimburse its own employees and other company-associated bills.

Best Small Cap Stocks in India based on past 5-year Returns

NameSubsector5 Year Revenue growth (in %)5 Year Returns in (%)
Nureca LtdPharmaceuticals566.60%46.4%
Xtglobal Infotech LtdSoftware Services491.66%3,454%
Gautam Gems LtdPrecious Metals, Jewelry and Watches437.95%-50.3%
Rattanindia Enterprises LtdPower Trading & Consultancy385.43%641.6%
Sobhaygya Mercantile LtdDiversified Financials347.30%211.6%
Stratmont Industries LtdNA344.36%129.4%
Balu Forge Industries LtdIndustrial Machinery330.17%50.6%
Flomic Global Logistics LtdDiversified Financials295.30%28,800%
Palco Metals LtdNA276.43%22.2%

(Price date as of June 22, 2022)

Disclaimer: The securities quoted are exemplary and not recommendatory. Past performance is not indicative of future returns

Important things to remember:

1. Do Not Blindly Follow Hot Tips

No matter how credible the source is, never follow a stock marketing tip blindly without conducting thorough research personally. Always select the stocks after doing proper research and analysis on the performance as well as the companies. While some tips can work out to give you huge benefits, the wrong ones can push you down under the risk pretty quickly. 

2. Eliminate Loser Stocks from Portfolio 

There is absolutely no guarantee that a stock will rise after a great fall. Know that it is extremely important to be practical about what is possible and what's impossible in the stock market. So, upon realizing that a stock is performing poorly in your portfolio, accept your mistake and sell it immediately to prevent further losses. 

3. Don't Exceed Your Investment Budget Abruptly 

While it's true that long-term investments are way better than other forms of investment, you shouldn't exceed your investment budget in a haste. Instead, decide on a fixed amount and invest it across various good stocks. Rather than investing in only one stock, divide your budget evenly across multiple good-performing stocks and shares. 

Disclaimer: The securities quoted are exemplary and not recommendatory. Past performance is not indicative of future returns

  • Is it worth investing in small caps?

  • Why is a small-cap fund risky?

  • Are small cap stocks good for long-term investments?

  • Do small caps have the ability to outperform the large caps?

  • What is the average return on small-cap stocks?

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