The Mini-Crisis in Small-Cap Companies

For the uninitiated, a massive rally in the small and mid-cap segment is looming. The rally becomes visible when you go up a rung. When you look at small companies with a market capitalization of a few hundred crores, you see crazy things happening. In most cases, their market capitalization varies between a few hundred and 20,000 crores. 

The retail investor frenzy in India has reached such extreme proportions that shares in companies that do not even record sales, let alone profits have gone through the roof. These include Transglobe Foods Ltd, a fruit and jam producer that has risen more than 4,300% this year, and the Shree Precoated Steels Ltd. real estate services which have gained more than 1,300%. Both companies posted revenue losses in the last fiscal year. 

One could argue that retailers know nothing about these stocks. But honestly, that’s not a correct assessment.

In many cases, you will see rallies of this kind, driven by a group of individuals bustling in small numbers. If it’s just a few shares changing hands, you’re likely to see massive price swings. Imagine two of us were trading stocks and you want to buy a stock with a 10% premium and sell it if you are at that price. Suddenly, at the last trade, the price jumps by 10%. 

In this case, hire a stock exchange operator who uses an ingenious network of traders and professionals to push up the price and then, when it becomes more attractive, sell it to the general public. For small quantities, the price can be even higher. Retail investors who want to make a quick buck when the stock rises, when the dust settles, are left with a stock that is essentially worthless. 

In this context, the Bombay Stock Exchange has published a circular detailing how it introduces price caps when it detects an abnormal interest in a particular stock. For example, if a stock rises in the last six months 6 times or more, in the last twelve months 12 times, in the last two years 20 times or 30 times in three years, it is subject to a special price cap. Clearly, BSE believes it can do better.

For most stocks, you would have a limit of 2% to 20%. This means that if the price exceeds this limit, you cannot trade the stock. There is no daily price limit unless you ask for it. 

This new newsletter puts you in a state where you see a number of stocks subject to weekly, monthly, and quarterly limits. Indeed, the moment people realize that trading is limited to selected stocks, there is a sell-off. People are panicking and the price of small-cap stocks is plummeting.

However, BSE was forced to update its circular. It added that restrictions would be imposed on small group shares of the X, XT, Z, ZP, ZY, and Y group with a market capitalization of fewer than 1,000 rupees and a price of more than rupees. This reduced the number of shares affected by the move. Others criticized the move, citing unnecessary interventions. 

Bottom line is that BSE does not want the small-cap market to overheat and explode and is prepared to intervene at every level to protect the interests of unqualified retail investors.

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