Building Conviction in Small and Midcaps

Small and midcap stocks have always fascinated investors. They represent the frontier of India’s growth story; companies agile enough to seize opportunities, often in sunrise sectors, and ambitious enough to scale rapidly. Many of today’s large-cap leaders once belonged to this universe, compounding steadily long before they became household names.

At the same time, this space is not for those lacking conviction. For every business that makes the leap from obscurity to leadership, dozens stumble. Lower liquidity, governance challenges, and higher earnings volatility make SMID (small and mid-cap) investing a double-edged sword.

This paradox, high potential, high risk, is what makes conviction so important. Without conviction, investors are tossed about by market cycles, selling in fear or buying in euphoria. With conviction, they can separate enduring wealth creators from fleeting stories and hold their positions through the inevitable ups and downs.

Why Conviction Matters More in SMID Caps

In large caps, businesses are widely tracked, data is abundant, and consensus is visible. In SMID caps, the information gap is wider. Market perception may swing from extreme optimism to extreme pessimism within months. A company can double in valuation not because of a fundamental shift, but because liquidity chases a narrow theme.

In such an environment, conviction becomes the anchor. It is the confidence that comes from evidence: governance checks, capital efficiency, earnings predictability, valuation discipline, and liquidity awareness. These guardrails allow investors to participate in the upside of SMIDs without being overwhelmed by their risks.

What Conviction Really Means in Practice

Conviction is built on process. It means you have enough clarity about why a company deserves capital, and enough humility to reassess when those reasons weaken.

Over the years, five signals have stood out as particularly powerful in separating enduring SMID winners from the rest:

1. Promoter Alignment and Governance

In smaller companies, promoters play an outsized role in determining long-term outcomes. Their decisions on capital allocation, disclosures, and debt levels can make or break a business.

2. Capital Efficiency

Growth is enticing, but not all growth creates value. A company that expands aggressively without generating returns above its cost of capital may destroy wealth over time.

3. Earnings Predictability

Predictability does not mean every quarter will be smooth. What it does mean is resilience, a business model that can absorb shocks and deliver steady profits over a cycle. Recurring revenues, diversified customer bases, visibility in order books, and margin stability are all signs of earnings quality.

4. Valuation Discipline

SMIDs can rerate dramatically. A stock can double or halve in a short span, often detached from fundamentals. This makes valuation discipline essential.

5. Liquidity Awareness

Liquidity is a key but often underemphasised aspect of SMID investing. Efficient entry and exit, without impacting market prices, is essential in practice.

Observations from Market Behaviour

Some of the most rewarding investment journeys tend to come from companies that combine strong fundamentals with disciplined execution. Often, such businesses begin with modest valuations, limited analyst coverage, and low liquidity. Over time, however, sound governance, efficient capital allocation, and consistent earnings growth can allow them to compound value steadily.

At the same time, market history offers several examples where ignoring warning signals proved costly. Elevated valuations based purely on optimistic growth assumptions, or overlooked governance concerns, have often led to underperformance when expectations failed to materialise.

The common thread across market cycles is that conviction tends to work best when it is anchored in discipline. Long-term investing is not about holding on blindly; it is about staying invested when the underlying evidence continues to support the investment thesis.

The Investor’s Perspective

For investors considering SMID exposure, the temptation is often to chase momentum, the stock that’s doubled in the past year, or the sector suddenly in the spotlight. But true conviction comes from deeper questions:

• Are promoters aligned with shareholders for the long term?
• Is the business generating returns above its cost of capital?
• Are earnings resilient enough to weather cycles?
• Is the valuation sensible relative to growth prospects?
• Does liquidity allow you to invest responsibly?
• And more such.

These questions improve the odds of finding the companies that will create lasting value while avoiding those that may falter.

Why Conviction is Not Optional

Volatility in SMID caps is inevitable. Sharp drawdowns, market overreactions, and temporary headwinds are part of the journey. What protects investors is not the absence of volatility, but the presence of conviction.

Conviction allows us to distinguish between noise and signal. It gives us the patience to hold a business through short-term pain if the fundamentals are intact, and the clarity to exit if those fundamentals deteriorate.

Closing Thoughts

Small and midcaps will continue to be an essential part of India’s equity story. They represent entrepreneurship, innovation, and the next generation of market leaders. But they are also where the risks are most concentrated.

Building conviction here is less about prediction and more about preparation. It means doing the work: assessing governance rigorously, measuring capital efficiency carefully, questioning earnings quality, and respecting valuations consistently.

This balance of participation and restraint is what transforms SMID investing from a risky endeavour into a powerful engine of wealth creation.

Disclaimer: This blog is for informational purposes only and should not be considered an offer or solicitation to buy or sell any securities or make any investments. We recommend readers take independent advice before making any investment decisions. Please refer to our Disclaimer and Disclosures for more details.