5 traps turning your portfolio red

To suggest there's a silver lining in this market correction might not be a popular view. This magazine is endorsing it anyway. No, we haven't gone cuckoo. Neither are we undermining the anxiety that your portfolio losses are causing you. We are simply saying that a bear market is not necessarily a bad thing. Rather, it's a great teacher. One that presents an opportunity to pause, reflect and self-correct. It's when the market turns red that your investing mistakes come to the surface. And you get the chance to hit the reset button. This downturn thus makes for the right time to reflect on some common but deadly mistakes that wreck investor portfolios, particularly during hard times such as now. We show you how costly these mistakes prove to be during market slumps and equip you on how to avoid making them. Stick until the end. #1 Chasing micro caps Like everything fun, micro caps are bad for you. They are the market's equivalent of a sugar high. Investors flock to them for their promise of extraordinary returns but mostly end up with nothing but a crash. As opposed to what flashy headlines will have you believe, micro caps don't even measure up to their supposedly slow-moving large-cap peers. In any five-year period over the last decade (except FY19-24), micro caps have severely underperformed large caps, including during market rallies. Take the latest bull market from September 2022 to 2024. Micro caps returned just 60 per cent on average, lagging dramatically when compared to large, mid and small caps that more than doubled their value on average. Why such an acute underperformance even during a bull run? That's because a handful of high-fliers create the illusion of strong overall performance, when in reality, an overwhelming number are wealth destroyers. Only 54 per cent of micro caps generated positive returns during this market rally while the other half lost money. Their lack of business quality, competitive moats or sustainable business models explains this poor performance. The data is unmistakable: micro caps underperform even in the best of times. And if this wasn't enough, there are other significant risks for you to bear in mind. The risks Spuriously bloated valuations: Many of these companies operate with negligible revenues, and yet, their market capitalisations are inflated. At least 50 micro caps reported revenues under Rs 1 crore as of FY24 but commanded market values over Rs 50 crore each! Illiquidity: It's easier to enter but often impossible to exit. There are few trading days and even fewer trading volumes. Nearly 430 micro caps traded on fewer than 50 per cent of market days last year, making it nearly impossible to exit without significant losses. Playground for manipulation: Their illiquidity, paired with high retail interest and low institutional participation, makes them ripe for pump-and-dump schemes. During bull runs, retail investors flood the market, but when the tide turns, liquidity dries up. Investors left holding the bag often find themselves stuck with near-worthless stocks. Before you take the leap of faith Dealing with micro caps is like playing with fire. There's a high chance you might get your hands burnt. However, if you are a risk-taker, approach this segment as you would a minefield - be selective, be methodical and above all, be aware of the inherent risks. Success here requires extreme caution. Use these stringent filters to separate the wheat from the chaff: Start with hygiene checks: Avoid companies with inconsistent revenue or cash flow, a history of fraud, questionable auditors, a messy capital structure, repeated management turnover or large related-party transactions. These alone disqualify most micro caps. Check promoter commitment: Look for firms where promoters hold at least 30 per cent stake, signalling skin in the game. Prefer companies in fast-growing industries that grow at or above the industry average. Look at return on capital: While sky-high returns on capital are rare in this segment, a consistent 10 per cent or more is a good starting point, especially if the company is improving. Search for niche leadership: Companies that lead - or are on track to lead - a well-defined niche tend to have more sustainable business models and pricing power. It's tempting to chase the few that will, against all odds, rise to greatness. But the reality is that an overwhelming majority either stagnate or disappear entirely. If you still want to bag the occasional multibaggers, understand that

This article was originally published on May 01, 2025.