In this conversation, Gupta explains why this divergence creates a fertile ground for active stock pickers, how his team’s forensic approach weeds out value traps, and which emerging sectors offer the most compelling opportunities in today’s small-cap landscape.
Edited excerpts from a chat:
The market seems to be inching towards new record highs, but are we pricing in too much hope and too little risk? Where do you think we are in the cycle?
While markets are approaching record highs, earnings are also moving higher. We believe there is a cyclical recovery, which should push corporate earnings growth higher. During the initial phase of the upcycle, some stocks may appear expensive. However, as growth catches up, these stocks become attractive. We believe that at this stage, the market is neither completely cheap nor expensive. Following the correction between September and March, several pockets of valuation comfort have emerged. Within these, one can find quality businesses with reasonable valuations and strong growth outlooks for building a decent portfolio.
You’ve launched a smallcap fund NFO when many smallcaps are still licking their wounds from the brutal correction that began last year. What makes you positive at this stage on smallcaps?
Our equity universe for small caps includes companies with a market cap above Rs 2,000 crore, giving us an extended universe of around 900 stocks. As of May 31, out of those 900, nearly 600 companies were down more than 25% from their 52-week highs. So, while there are concerns that small-cap levels are elevated, there’s a long tail within the category that hasn’t performed.
If you look at the Nifty Small Cap 250 index and track the bull market that began around the Silicon Valley Bank crisis, the index has doubled since then. This index spans 52 industries, of which only 17 have outperformed the index, while 35 have underperformed and have recorded lower returns in comparison to the index. It’s a fairly level market and a heterogeneous one at that. It’s a good environment for active stock selection. This is the near-term reason why I believe this is a good time to look at small caps and curate a decent active portfolio.
What does “value” mean in your smallcap universe? Low PE stocks that come within the parameters of quality and growth appear to be rare.
By value, in our small-cap universe, we refer to companies trading below their intrinsic value. These are often businesses where the long-term growth outlook remains intact, but near-term mispricing creates an opportunity. In some cases, even quality companies with strong growth potential may appear optically expensive on a price-to-earnings basis. However, the market may be underestimating their ability to scale, expand market share or deliver higher return on equity.
Altogether, for us, any stock trading below its intrinsic value qualifies as a value opportunity; however, only after passing through our filters of quality and governance.
How do you separate turnaround stories from value traps? Especially in a space where promoter pledges and poor governance often go unnoticed until it’s too late?
In small caps space, we believe the most important part is eliminating rather than selecting. Our holistic approach towards careful stock selection helps us filter out the best of the best. So, we eliminate at the first level. The first level of quality comes as forensic research, where we’ll eliminate bad management, with a bad track record on related party transactions and those that have litigation issues.
Then we come to the quality, growth, and value triangle. That is, the quality of the business, the industry growth it offers, and the valuation it is available at. Among these, the most sacrosanct is quality. Once we test for quality in terms of governance and fundamentals, then we look at the business’s ability to gain market share and maintain profitability, growth, return ratios, and capital efficiency. Lastly, we assess value versus growth, looking at the risk-reward.
Everyone talks of forensic filters and governance frameworks. What’s your team’s actual red flag checklist when it comes to smallcaps?
We have built an internal forensic team. Out of the 900 stocks we see from the small-cap broader universe, there is a strong list of eliminations that we’ll do based on the forensic analysis that we perform. As part of this, we will conduct extensive data-based checks, examine related party transactions, go through auditors and auditor reports, assess who the bankers are, and review other regulatory filings of the company. This allows us to filter out companies where we don’t want to invest.
So, we begin with this first level of negative screening, and then move to the positive, where we look at quality, value, and growth. There we will take a look at the quality of the business, the growth that it offers and the industry growth along with the valuations it is available at.
Which sectors or themes within small caps are looking mispriced to you right now and what’s your favourite contrarian bet?
We are seeing opportunities emerging in small caps that are unique to the segment. Over the last three to five years, new industries have emerged due to government reforms, technology, and structural changes. These naturally lack large-cap representation since the sectors themselves are still new.
Among these, the defence looks like a great opportunity, though we have to be careful and selective because valuations have gone through the roof in some cases. Similarly, opportunities in power equipment are opening up, with the government planning significant investments over the next five to seven years. which opens up a space. The online marketplace space is gaining momentum. That opportunity was never there seven or eight years ago. Also, electric vehicles, a space that did not have investable opportunities earlier, now represent a growing ecosystem.
What is going to be the diversification strategy in the Smallcap Fund? How many stocks would you want to own in a typical market phase without over-diversifying but spreading risk across counters?
As I mentioned, any company with a market cap of more than ₹2,000 crore is part of our broad universe, which includes close to 900 small caps. From there, we filter. We are looking at anywhere between 40 to 100 stocks. The plan is to be quite well diversified.
The general view in the market is that the Q4 earnings season was relatively better for midcaps rather than smallcaps. What is the kind of earnings growth that you are expecting from small caps in general in FY26?
So far in FY26, we’ve seen easing monetary policy, rate cuts, higher liquidity, and earlier tax reductions. All of these developments support a cyclical recovery in the Indian economy. This should begin reflecting in corporate earnings going forward.
The medium-term equity outlook appears positive, particularly for the broader markets.
However, caution is advised in export-oriented sectors due to U.S. economic uncertainty and potential tariff impacts. Geopolitical risks may also cause intermittent volatility.
As the economy picks up, smaller businesses and broader market participants tend to benefit. The small-cap space, especially after the recent correction, looks promising with bottom-up opportunities. Investors may consider quality small-cap funds to tap into long-term growth.
