Mind the speculative froth in small-caps – The Hindu BusinessLine

Clipped from: https://www.thehindubusinessline.com/opinion/mind-the-speculative-froth-in-small-caps/article37545549.ece?homepage=true

It’s time SEBI took a closer look at the price action in some of the small-cap counters to investigate price manipulation

Much has been written about the Sensex and the Nifty50 gaining over 100 per cent from the pandemic lows and valuation in the benchmarks hitting record levels. While the rally in benchmarks can be justified somewhat by liquidity gushing in to the market and the fact that many of the larger companies improved their profits during the pandemic, the breathless rally in some of the small-cap stocks is clearly irrational and purely due to rampant speculation.

There are many other similar stories of penny stocks (stocks trading at price below ₹1), coming to life since last March. Many counters which have been prone to price manipulation in the past are also witnessing heightened action once again. The vast droves of new investors entering the market are highly susceptible to falling prey to tips and rumours and investing in these stocks only to get badly singed when the tide turns. It will be good if the market regulator, SEBI takes a closer look at the action in some of the small-cap stocks in order to prevent price manipulations and speculative excesses from eroding market’s credibility.

Rising tide

The rising tide of liquidity lifted stock market over the last 20 months and all stocks — the good, the bad and the ugly — have been in an equally upbeat mood. While stocks delivering negative returns were rare, multi-baggers were aplenty.

BusinessLine analysis of the returns of around 2,267 listed and actively traded stocks from March 2020 lows shows that only 94 stocks delivered negative return in this period. This effectively means that almost all the stocks bought by investors delivered returns. Of the top 100 stocks that make up the large-cap segment, only one stock — YES Bank — recorded decline in stock price in this period with all other stocks appreciating. Of the 250 mid-cap stocks, only seven stocks recorded losses and of the remaining 1,917 small-cap stocks, just 87 stocks registered price decline.

The price gains in almost all segments were spectacular too. Of the large-cap stocks, half the stocks doubled their price since the March lows and one out of 10 stocks gave over two-fold returns.

The mid-cap stocks bettered their larger counterparts with almost two-third of the stocks in this segment more than doubling their price from the Covid lows and one-third of the stocks turning multi-baggers.

The rally in the small-cap stocks however trumped the performance of both the large and mid-caps. Around 75 per cent of the small-cap stocks more than doubled their stock price since the March 2020 lows and half the stocks in the segment delivered more than 200 per cent returns. If that is not astounding enough, around 322 small-cap stocks delivered more than 500 per cent returns.

In the fundamentally sound stocks, which rank in the top 500 by market capitalisation, the steep rally may have stretched valuation, but they will not suffer too much in the long run.

But the rally in the cats and dogs (stock market terminology for penny stocks or stocks with no fundamental worth which are traded only for speculation) is a cause for concern as these stocks could never reclaim the current heights and result in investors losing all the capital invested in them.

Excessive speculation

A closer analysis of the return and financial metrics of the small-cap companies highlights the extent of madness prevailing in the small-cap space.

Of the 1,971 small-cap stocks analysed, 540 stocks traded at less than ₹10 as on March 31, 2020. The market capitalisation of these stocks has jumped 540 per cent since then. These stocks include 110 penny stocks which traded at less than ₹1. With liquidity on these counters being extremely low, circular trading to take stock prices higher is far more easy on these counters. Most of these stocks were languishing at lower prices due to continued losses, large debt and many of them are also in liquidation.

Proseed India’s stock price movement is a case in point. The agri-biotech seed manufacturer has sported negative networth since 2014, with its capital eroded by losses. The company is also undergoing insolvency proceeding. Yet the stock price exhibited exuberance, racing from ₹0.28 in March 2020 to ₹99. Tata Tele Maharashtra is another example. The company has consistently recorded losses over the past decade with rare exceptions, and it had negative networth towards the end of last fiscal year. The stock has appreciated 3,550 per cent since last March.

Around one-fourth of the small-caps recorded either losses or profit below ₹1 crore in the September 2021 quarter. 200 stocks had negative networth and about one-tenth of these stocks had negligible revenue. But most of these stocks have attracted attention and registered price appreciation over the past 20 months.

The smallest of the listed stocks have very low liquidity and are not traded on many days. Institutional participation is also extremely low on these counters making them easy targets for price manipulation. Cases of targeted manipulation of stock prices has been witnessed often in the past, including in 2000 and 2006.

SEBI has state-of-art surveillance system that can monitor every trade. But the problem is the lack of manpower to investigate the mischief being brewed in hundreds of such counters. That said, it’s time the regulator took note of the rampant speculation in the small-caps and came down on at least some perpetrators of this frenzy so that the mood is tempered and naïve investors are not misled.

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