The body and soul of investing

Is this a good time to talk about micro caps? You must be wondering. To put it mildly, the great small-cap rally has run out of steam. In fact, we seem to be in a full-fledged crash. The equity markets, on the whole, are running scared, and indeed, by the time you get this issue in your hands, your mood may have changed. Or maybe not, who knows.

On balance, it probably doesn't matter. The stock markets have risen so far and so fast that every Indian investor is sitting on big gains, or at least should be, unless they've done something really foolish. A little hiccup or two will just present an opportunity to buy stocks at better valuations than were available till a few days ago.

The larger question that faces investors is where to seek opportunities for big gains in a market where everything looks fully (or excessively) valued. And the answer, when you think about it, is obvious. We'll have to do some 'real' equity investing and hunt for micro-cap businesses that will likely have the potential for huge growth over a decade or so.

Micro-cap investing is fundamentally different from other types of equity. It's basically the body of equity investing but with the soul of angel investing.

That's right - exploring micro caps requires a mindset akin to a venture capitalist rather than a traditional equity investor. You're not just looking at numbers and charts; you're betting on the future potential of these companies, many of which are in their nascent stages with innovative or niche products or services that could disrupt markets.

This approach demands a higher tolerance for risk and a deeper dive into the businesses' fundamentals, management capabilities and market opportunities. It's about finding those hidden gems that have not yet been recognised by the broader market and are thus, undervalued.

The potential rewards of micro-cap investing are significant, but so are the risks. When you look back at the last 10-20 years, there are plenty of examples of ten-baggers or hundred-baggers or maybe even more, but there's no shortage of no-baggers as well. In large caps and even the larger mid caps, if you do a modicum of evaluation, there won't be any disaster. Micro caps make no such guarantee. The risk is high, and the potential for rewards is enormous. Hence, it is crucial for investors to conduct thorough due diligence and possibly allocate only a portion of their portfolio to such investments, considering the high volatility and liquidity concerns associated with microcaps. In this landscape, patience is key.

The true value of a micro-cap investment may take years to unfold, but the payoff can be extraordinary for those willing to wait.

Earlier, we've covered micro caps in different ways, but our cover story of the month is our first ever on how readers should invest in micro caps. Our team has looked at the scale, past, and present of micro-cap investing. Our focus has been to try and create a framework for understanding micro-cap success rather than let it stay in what I might call 'hunch-based' investing. In larger companies, having a process-driven framework for stock selection works well. In micro caps, the challenge is much bigger.

However, this challenge makes micro-cap investing exciting and potentially rewarding. It's like being part of a detective story, where you're piecing together clues about a company's potential that isn't apparent to most investors. Our cover story dives deep into seasoned micro-cap investors' methodologies to uncover these opportunities.

Micro caps represent a frontier of the equity markets that is less explored and understood. But for those willing to do the hard work of discovery, it can offer a path to huge rewards. Or, it can offer a path to big losses. It depends on how you approach it. Turn to the cover story of 'Wealth Insight' April issue and understand what we think is the right way.