How to find smallcap proxy stocks in this market

We recently looked at the stock of Asian Paints, a company that has inspired dedicated chapters in books on investing. However, it seems to be struggling to maintain its hegemony.

At 52x, the stock is trading at a discount to its five-year and ten-year median PE (price-to-earnings) multiples. The stock is quite a distance from its previous peak and closer to its 52-week low.

You could blame this underperformance on the rising competition in the paint sector, especially with the entry of Grasim, that expects to generate ₹100 bn in gross revenue in three years.

And it's not just one challenger.

In recent years, some big names like Pidilite and JSW group have entered the segment. While consumers are spoilt for choice, leading incumbents have reasons to be nervous.

But there are also some entities benefitting from these developments. Consider Moldtek Packaging, a market leader in rigid plastic packaging.

The company takes care of the packaging needs of leading companies in the paint sector, among others like lubricants, food and FMCG and soon pharma. It makes plastic containers in which the product is sold. Asian Paints has been one of its biggest clients.

Let's now see what the entry of Grasim means for this proxy play.

Moldtek has already set up two plants and will be coming up with the third one to supply packs for Grasim paints.

While the paint companies can fret over market shares, irrespective of who gains or loses, this smallcap company is an undisputed beneficiary of the rising competition.

And that's the beauty of smallcap proxy plays.

A similar phenomenon is playing out in the auto sector as well.

In FY20 alone, Maruti Suzuki used to command a share of about 51%. In FY24, that share has come down to 41%. Companies like Kia, Volkswagen, Toyota, MG have made significant inroads in the domestic market.

While the competition is heating up in the auto OEM market, it's an opportunity for auto ancillary companies. These are the companies that supply auto parts to leading auto OEMs, like Maruti, Bajaj, M&M, Tata, and others.

A case in point is Gabriel India, a market leader in shock absorbers. As the Indian car market is moving towards premiumisation, the company is adding a sunroof business. It has got clients like Hyundai and Kia.

The growing number of players in the auto segment is positive for other companies in the segment like Minda Corp, Pricol, Fiem, among others.

Even as large companies are navigating through the challenge of responding to EV disruption, the companies mentioned above see this as an opportunity for product premiumisation.

It's no wonder that a lot of these auto ancillary players are confident of beating the industry's growth rate.

Another instance of proxy players gaining prominence is the entertainment industry.

Movies are made on huge budgets these days. A lot of this budget is allocated for visual effects and animation.

The debate is still hot on whether the influx and easy access to OTT channels will structurally impact players like PVR and the movie industry itself.

Irrespective of who gains the lead, companies catering to VFX, and augmented effects seem to be in for a good time.

Consider Phantom Digital, a leading creative visual effects and studio offering end-to end services for film, web series, game cinematics and commercials.

Its projects include Avengers, Bird Box, Joker, Adi Purush and Salaar to name a few. Even if a movie becomes box office failure, the company stands to gain business.

Other players in this space include Prime Focus and Basilica Fly Studio.

Pick any theme, be it infrastructure, green energy, defence, railways, digitisation... behind the chased after front runners, there is likely to be a group of companies that are critical for the big companies to play the cycle.

For instance, a company like RITES, a leading player in the engineering and transport consultancy sector in India, being asset light, could be a better choice to ride infra cycle than companies that need huge investments generate revenue.

I have mentioned only a few examples here, but the message is loud and clear: The big profits could be in the pick-and-shovel makers and suppliers. In investing parlance, you could call it proxy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com