There are two parts to investing via smallcase:

• the tooling around managing a watchlist of stocks, which enables us to execute transactions at portfolio level rather than at scrip level

• the basket of stocks offered by smallcase themselves, such as the Low Risk - Smart Beta smallcase, which can have a collection of stocks, ETFs, commodities etc.

There's no doubt that the usability of smallcase, as a tool, to manage a stock portfolio is quite good. When we say "usability", we mean the user experience of using the smallcase website and its aesthetics. If you already have a plan to invest in a collection of stocks of your choice, you can create a watchlist and place orders using smallcase.

The second aspect requires smallcase having a proven track record. The people responsible for maintaining the various basket of stocks on their platform should be capable stock pickers themselves.

We're mostly concerned with the second aspect in this article.

Here's why investing in the baskets of stocks offered by smallcase might not be a good idea

• Depending on the portfolio turnover, there can be significant tax drag for you since you'll be buying and selling units regularly.

  Smallcase is typically known for rebalancing their portfolios once every 90 days, for most of the portfolios.

  The act of rebalancing could result in some stocks being sold from your smallcase portfolio, which would also attract various charges associated with selling a stock.

  Since these are all negative cashflow transactions in your portfolio, your portfolio XIRR would end up falling behind the advertised CAGR of the same smallcase, over the same time period.

• There's a lack of a proven track record that can be independently audited and verified.

  Asset Management Companies (AMCs) are legally required to publish the Net Asset Value (NAV) of their mutual funds everyday, and the list of holdings held by their mutual funds every month. This means that an AMC can’t give you random numbers. They are forced to keep everything in the public’s eye.

  This is not true for smallcases.

• Smallcase is selling Backtested Models.

  Backtesting needs to be free from various biases, such as look-ahead bias. Strategies derived from a backtest would always show great results when simulated over the same time period.

  It’s hard to say if that’s what’s happening here; but since the appropriate data and disclosures around their modeling and backtesting is not present in the public domain, it makes sense not to just take them at their words.

• There used to also be some concerns around smallcase not being upfront with some of their numbers. They include backtested portfolio in computing returns of the smallcase, which is not at all how any asset management services report their returns.

  According to their recent blog post, they’ve updated some of their reporting to exclude such misleading data that could have potentially enticed curious investors to invest in hopes of high gains.

  Link to smallcase blogpost | archive.org link | archive.is link

Finally, keep in mind that past returns are not indicative of future returns; and asset returns can be very different from portfolio returns.

What would make the basket of stocks offered by smallcase good investments?

A good investment is an outcome of a fact-based logical process. It should be rooted in better reasoning than just reported past performance of the asset.

Here are a few bars that the baskets of stocks offered by smallcase has to meet for it to be an investment worth considering:

• Disclosure on Insider Holdings

  It’s easy to trust an asset if the entity offering it themselves believe in the same, and invest in it.

  Smallcase should, ideally, indicate net insider holdings against each basket of stocks that they offer on their platform.

  Anyone can come up with a portfolio of stocks. However, if people from smallcase showcase that they're investing in their own basket of stocks offered on their website, it’d engender more trust in smallcase.

  A commonly accepted qualitative metric of mutual fund selection, is to look at key insider holdings — after all, why would someone else invest in a basket of stocks, if the entity offering it cannot get their own employees to invest in those? AMCs have to disclose insider holdings in their mutual funds as a percentage of net AUM to show how key insiders are invested in those.

  This clarity is need of the hour.

• Disclosure on Portfolio XIRR

  Smallcase Baskets, by design, are a product where return difference due to both behavior gap and costs can be very high. They're not a standard buy and forget product.

  Behavior gap is a well-defined term. In short, it denotes the difference between underlying asset’s returns, and returns as investors see in their portfolio, due to behavioral reasons.

  This is a well-known phenomena in investment, and various firms over the years have published studies on anonymized bulk data, that even when assets perform decently, most investors who invested in those assets, over same period of time, wouldn’t see those returns in their portfolio. It’d be significantly lower.

  A mutual fund is structured as a trust, so rebalancing doesn’t create any tax events for end investors who are invested in the same mutual fund. As for costs of STT, brokerage, and other fees associated with selling; all covered under expense ratio of the fund, which would be minuscule on a per-investor basis.

  As discussed above, mutual fund NAVs are already post-cost, therefore so are the returns.

  In addition to reporting CAGR of the portfolio, one should also expect to see on an average how a typical investor’s portfolio has performed, after costs, in that smallcase basket.

  Publishing these numbers would only make it easier to trust smallcase that they have the best interests of investors in mind.

• Disclosure on Portfolio History

  Due to periodic rebalancing, the latest version of stock portfolio of a smallcase basket won’t be how the same as it was a few months ago. It could even be wildly different from how it was a few years ago.

  If they were to publish stock portfolio history of their own smallcase baskets independently, it gives an investor an opportunity to validate:

  • whether the smallcase basket in question has stayed true to its mandate or not, as the theme of the smallcase basket dictates

  • whether the actual computed CAGR of the smallcase basket matches the CAGR advertized on the smallcase website

TL;DR: use the product if you like its usability; but not because you think their investment advice alone would make you great returns.

When using the smallcase website, you should use it as a tool to narrow down a watchlist of stocks and then do your own due diligence into underlying companies before investing in them.

Intro 💫

In India, there are plenty of small and big brokerage platforms available to you, that let you open trading and demat accounts for equity, bonds, ETFs (Exchange Traded Fund), commodities etc.

Read this to get an overview of features / functionality of popular brokerage services, and the costs you'd be incurring if you were to go with one of these.

Broadly speaking, there are two types of brokerage services in India at present:

• Discount Broker

• Full Service Broker

Full service broker 🏦

These are the traditional stock brokers, most commonly sharing a parent corporation with a big bank, which offer more than just buy / sell / hold functionalities. To name a few add-on services, for instance, most full service brokers provide:

• Brokerage reports and analysis

• Stock advisory

• Portfolio management / wealth management services etc.

Typically, these platforms have both online and offline presence to serve you.

Axis Direct, Citibank Securities, HDFC Securities, ICICI Direct, Kotak Securities, Motilal Oswal Financial services, SBI Securities etc. are examples of full service brokers.

A tell-tale sign of a full service broker, is that they charge a percentage of your investment as brokerage fee, which means costs scale with investment amount.

Discount Broker 💻

After the penetration of internet, it became less and less necessary to have a physical location to cater to the customers' needs.

So with reduced staff by not having physical customer service locations, discount brokers are offering the trade with discounted rate.

They also don't provide the research / advisory services, portfolio or wealth management services etc. to keep the operational costs low.

As a result, they can afford to charge lower trading fees. Most discount brokers have zero fee on equity delivery trades, and close-to fixed fee for intraday trading / BTST etc.

One also needs to keep in mind economics at scale. By offering lower costs, these services are reducing barrier to entry. That means larger number of users, and higher trade volumes. Even if per trade costs are lower, it has the potential to help these discount brokers pocket higher revenue than some of the full service brokers.

Such businesses want the volume, and while they operate on lower revenue margins per trade (not to confuse with margin provided by a broker) compared to a full service brokerage; they make bank on volume.

A few popular ones are listed below, in alphabetical order.

1. 5Paisa

2. Groww

3. PayTm Money

4. Upstox

5. Zerodha

Comparison of Discount Service Brokers

The following table is a comparison-at-a-glance for these discount brokers. The information presented in this table maybe out of date at any moment in time. We'll do our best to update this table whenever we come across new information.

*Add-on pack: Some platforms offer subscriptions plans which will enable to advanced users to get more features, reports, reduced trade fee etc. for a monthly fee.

*Number of accounts: It's indicative of trust, as larger user-base might mean more audits & compliance requirements. These numbers change everyday, so exact value is not that important. By the time you're reading it, most likely exact number of accounts on each of these platforms could be higher than what you see in the table above.

The above table compares some popular discount service brokers, in terms of the following parameters:

• What are the aspects the platform make easy for you (USP)

• What are the factors the platform make harder / costlier for you

• Fees / charges on various types of trades

• Funds credit options to trading account, and time it takes to credit the amount

• Approximate number of accounts on the platform, as reported, at the time of writing this

Wrapping Up 🎁

Selecting a brokerage service might require some care. Unlike picking a mutual fund app, it's not that easy to migrate between brokers. This is not an easily reversible decision.

Some brokerages make it so easy to trade, that you might end up placing too many orders, and lose big on brokerage fees.

Most brokers ideally provide a cost calculator to get an estimate of various fees & charges that might show up against your account, for the volume of trades you'd want to execute.

We highly recommend being careful with F&O, intraday trading and BTST trades. Ideally, as a retail investor, if you're looking to buy for long term, most discount brokers are quite cost effective.

An important aspect to understand, is your broker has lot of control over your holdings; unlike your mutual fund app.

For instance, the Karvy brokerage scandal of 2019-20, exposed how even full service brokers can exploit dormant holdings, keeping those shares as collateral for their other business arms to get loans.

It's of paramount importance that you evaluate a brokerage service on these two parameters:

• Does the brokerage house have a history of lending out shares, to arrange for some liquidity?

• Does the brokerage platform have enough retail accounts, that they'd be subject to more audits and compliance?

This is why it's important to go with a broker that has been around for past few years, have healthy financials of their own, and have good volume. On that front, Zerodha comes out ahead of other brokers covered above.

It doesn't just end at choosing a broker with decent fees and nice UI / UX. You've to keep track of your holdings outside of the brokerage app. Check your monthly CDSL or NSDL CAS, to confirm your holdings are as shown in the portfolio section of your broker's app.

Introduction

Though stock-screeners calculate a lot of things, you must do your own calculations too. You will miss a lot of good opportunities or make some expensive mistakes if you consider only the pre-calculated values.

The objective of this article is to explain the importance of your own calculations. The article provides examples where the screening portals might not give right results. The examples are not to demean any portal but to explain the reasons for the difference in numbers across websites.

Examples of dividend yield

Lets consider the dividend yield of Britannia Industries as on 29th April 2021 (#britannia-industries-dividend-yield):

Screener.in:    4.18%
MoneyControl:   0.95%
MorningStar.in: 1.78%

Correct value:  ~2-5%
Depends on your judgement on how repeatable these dividends are

The differences are because of different treatments of interim dividends. While screener.in considers all the interim dividends of FY21, MoneyControl considers only FY20's dividends. MorningStar considered only one of the two interim dividends (probably assuming the other one as a one time special dividend).

Another interesting case is that of Majesco. The dividend yield as on 29th April 2021 on various websites is (#majesco-dividend-yield):

Screener.in:              1,353 %
MorningStar.in:           1,351 %
ValueResearchOnline.com:  1,355 %
(Yeah, 1000+% in all the cases)

Correct value:            ~0-5%

The company sold off its US subsidiary and distributed most of the proceeds from the sale. The US subsidiary contributed over 90% of the company's revenues and assets. Thus it is safe to assume it was a one time dividend. The future dividend yield in such a case would be around 0 to 5%.

Relying on any screener and buying highest dividend yields shares blindly can make costly errors in such cases.

Examples of PE Ratio

Let's consider PE ratio of ONGC on different websites as on 29th April 2021 (#ongc-pe-ratio):

MorningStar.in:           shows blank
Screener.in:              13
ValueResearchOnline.com:  144
NseIndia:                 79
MoneyControl.com:         146

The company reported:

Standalone TTM EPS:       ₹ 1.32
Consolidated TTM EPS:     ₹ 0.73
The price was:            ₹ 104
Exceptional losses:     ~ ₹ 7.98 / share

Exception losses were of 4899 Cr pre-tax on an old GST liability.

The differences across websites is because:

• ValueResearchOnline and MoneyControl considered consolidated EPS as reported by the company.

• Screener.in considered consolidated EPS but added back the exceptional losses.

• BseIndia.com and NseIndia.com considered standalone EPS.

The correct PE depends on your individual judgement on how you interpret the impact of exceptional items on future earnings.

The PE based on last 5 years average earnings will be 8.29. This is what Benjamin Graham recommends to use in such cases.

Operating margins and gross margins

The text-book definition of gross profit margin (GPM) is sales - cogs.

COGS is cost of goods sold.

Most websites will show the gross margins on this standard definition. However, this can sometimes be misleading.

Example in case of TCS - screener.in shows the GPM as 100%. This is because TCS has no inventory. But the correct metric for COGS in this case should be their employee cost.

Similarly in case of banks, most websites (eg screener.in), don't consider their interest cost in OPM (operating profit margin) and GPM (gross profit margin). Thus these numbers are shown exceptionally high.

Screening companies on margins can often yield incorrect results for:

• Insurance companies

• Banks

• Finance companies

• Mining companies

Return ratios

In case of Abbott India, the ROIC reported as on 29th April 2021 is (#abbott-india-roic):

Screener.in:        22.90%
MorningStar.in:     21.53%
TijoriFinance.com:  131%
Correct value:     ~138%

The company held fixed-deposits (cash equivalents) of ₹ 2,197 Cr in FY20. While TijoriFinance excluded these cash-equivalents in the calculation of capital employed, other two websites didn't exclude it.

These differences in the methods of calculating ROCE, ROIC, ROA and other return ratios can yield wildly different results. You can sometimes miss some interesting companies because their calculated return might be much lower than their economic return ratios.

Summary and Wrap-up

The auto-calculated ratios on websites can often be different from manual calculations. Those calculations will often miss sector specific adjustments or "special cases" which are too frequent in the investing world.

Don’t rely blindly on any portal or report. Do your own due-diligence.Cross-check the numbers with your calculations.

Trust, but verify.

Though the websites and portals do their best, there are lots of nuances in the footnotes and schedules which are hard to capture. This mandates the due diligence from the investors and also provides opportunities to them.

To understand how to use a screener, you might want to check this out

Footnotes

Web-archives for case studies

Britannia Industries dividend yield

• Company's dividend history

• Screener.in

• MoneyControl

• MorningStar.in

Majesco dividend yield

• Company's sale of its US subsidiary

• Company's presentation about dividend

• Screener.in

• MorningStar.in

• ValueResearchOnline.com

ONGC PE Ratio

• Company's exceptional losses

• MorningStar.in

• Screener.in

• ValueResearchOnline.com

• NseIndia

• MoneyControl.com

Abbott India ROIC

• Screener.in

• MorningStar.in

• TijoriFinance.com

Market Corrections Aren't Unusual

A correction or a crash in the stock market isn’t an unusual event, despite what one might think during such an event. According to Fidelity Investments,

Since 1920, the S&P 500 has, on average, experienced a 5% pullback 3 times a year, a 10% correction once a year, and a 20% decline every 7 years.

Of course, similar behavior can also be observed in India with the S&P BSE Sensex index in the past 20 years, starting from 1980 to 2020. According to this blog post by Funds India (archive.org link | archive.is link),

In fact, a 10-20% temporary decline is as common as your birthday and you should expect this almost every year.

Market Correction Should Never Be the Only Reason to Buy Stocks

A market correction should never be the only reason for buying stocks, unless you’ve already done your due diligence on the stocks you’re looking to buy.

It might sound surprising but the price of a stock is one of the least important things about a stock. At any point in time, the price of a stock may, or may not, reflect the underlying business fundamentals of the company in question.

Let’s assume that you didn’t do any due diligence on the stocks you bought during an ongoing market correction after asking for stock recommendations. What would you do if the price of a stock you bought falls by more than $50\%$? Would you sell it or hold it? What would be your reason for taking either of those actions?

Even if we assume that the stock recommendation comes from a person or an entity which apparently knows what they’re doing, you shouldn’t be willing to bet your hard earned money on borrowed conviction. They might find a better opportunity and sell the stock suggested earlier to buy another stock. Would they keep you updated every step of the way? They can also simply be wrong.

One has to realize that it’s much easier to buy a stock than it is to hold it or sell it. Although one doesn’t necessarily need to have conviction when buying a stock, holding a stock requires considerable research, devotion of time, and conviction, often in the face of extended downturns or a sideways market, even if one knows that the underlying business fundamentals are strong. The act of selling a stock is even harder and often the source of regrets among investors. People often have trouble letting go of a stock they’re mentally, and sometimes emotionally, invested in, even if the stock should be sold. Sometimes, people sell too soon and then regret it later.

A research paper (archive.org link | archive.is link) from the University of Chicago and MIT Sloan School of Management suggests that,

while there is clear evidence of skill in buying, selling decisions underperform substantially — even relative to random selling strategies.

What Should You Do?

Assuming you’ve already done your due diligence on a stock and have enough conviction to hold it in the face of possible downturns, you may go ahead and buy the stock you want. However, if you haven’t done your own due diligence on a stock, it’s better to stay away from it. Asking for recommendations from others is a futile act because borrowed conviction will not help you in the time of crisis and the person who recommended the stock may not hold the stock in the near future or might be completely wrong about his choice.

However, if you still have the urge to buy something during a market correction, it might be relatively better to invest more in mutual funds you already hold.