---
title: "Separating the Wheat from the Chaff: Avoiding Blowups in Small Caps | Quarterly Newsletter - March 2025 / Q4 FY25"
period: "Q4 FY25"
published: 2025-04-30
modified: 2025-04-30
url: https://equitreecapital.com/insights/newsletters/march-2025
markdown: https://equitreecapital.com/insights/newsletters/march-2025.md
authors: ["Pawan Bharaddia", "Ssuneet Kabra"]
publisher: "Equitree Capital Advisors Private Limited"
language: en-IN
---

# Separating the Wheat from the Chaff: Avoiding Blowups in Small Caps

Quarterly Newsletter, March 2025 / Q4 FY25. Published 30 April 2025 by Equitree Capital. About 14 minutes to read. Web version: https://equitreecapital.com/insights/newsletters/march-2025

> Quarterly Newsletter published 30 April 2025. Figures are as of the dates stated in the letter and are not updated after publication.
> Performance data has not been verified by SEBI. Past performance is not indicative of future returns.
> Current performance, with its as-of date and benchmark: https://equitreecapital.com/pms
> Performance relative to other portfolio managers in the same strategy: APMI, https://www.apmiindia.org/apmi/IaInsight.htm?IAID=407
> Not investment advice, an offer or a solicitation.

> The best opportunities often come in times of fear and uncertainty — not comfort and calm.
>
> Howard Marks

Dear Investors,

Amid the prevailing noise and broader market headwinds, **2025 has begun on an exceptionally encouraging note** for us at Equitree.

As we move ahead, we remain focused on navigating volatile markets with discipline, agility, and a sharp eye for high-conviction opportunities in the small-cap space.

## Our Performance

| Investment Period | 1 Month | 3 Months | 6 Months | 1 Year | 2 Year | 3 Year | 5 Year |
| --- | :---: | :---: | :---: | :---: | :---: | :---: | :---: |
| Emerging Opportunities | 5.71 | -13.45 | -7.69 | 38.26 | 61.88 | 36.79 | 51.76 |
| BSE 500 TRI | 7.32 | -4.39 | -11.84 | 5.96 | 21.85 | 13.74 | 26.31 |
| Outperformance | -1.61 | -9.06 | 4.15 | 32.30 | 40.03 | 23.05 | 25.45 |

As of March 31, 2025. Returns are computed on a TWRR basis, net of fees & expenses, and not verified by any regulatory authority/SEBI.  
Returns over one year are annualized. Individual portfolio performances may vary.  
Source: Nuvama Custodian Services, Equitree Capital[1].

## 01. Strong Resilience Even During Drawdowns

While we have maintained long-term outperformance, **Q4 FY25 was not without volatility**. Our portfolio fell ~13% vs. BSE 500’s 4.39% drawdown — more aligned with the **NSE Small Cap Index’s ~14% fall**.

However, the portfolio showed **strong relative resilience** across multiple drawdown phases:

• During **Jan ’22 – Mar ’23**, the Small Cap Index fell ~17%, while our drawdown was just ~6%.  
• Over the **last 6 months (Sep ’24 – Mar ’25)**, the Small Cap Index dropped ~16%, while we declined only ~7%.  
• **Notably, in both phases, the broader markets including many small/mid caps corrected more than 30%**.

### Drawdown Analysis

> **In Focus:** **71% of companies in the ₹200–5,000 cr market-cap universe are down more than 30% from their 52-week high** in the recent correction.

| Drawdown Window | Equitree | NSE Small Cap | Outperformance |
| --- | :---: | :---: | :---: |
| Russia-Ukraine War (Jan 2022 – Mar 2023) | -5.6% | -16.7% | +11.1% |
| Recent Correction (Sept 2024 – Mar 2025) | -7.7% | -16.1% | +8.4% |

Source: Nuvama Custodian Services, Equitree Capital. Data till 31 March 2025[1].

[Chart: Equitree Capital vs NSE Small Cap 100. Cumulative returns rebased to 100, Dec 2021 – Mar 2025. Drawn on the web page: https://equitreecapital.com/insights/newsletters/march-2025#resilience]

Series: Equitree Capital, NSE Small Cap 100.

Source: Nuvama Custodian Services; Equitree Capital. Series rebased to 100 at Dec ’21 month-end. Returns net of fees & expenses, TWRR basis. Universe: ₹200–5,000 cr market capitalisation.

### Why have we been able to cushion downside better?

#### Earnings Growth

In a market largely starved of profit visibility, our companies continued to deliver. The **median PAT growth for the portfolio in the first nine months of FY25 stood at 19% YoY**.

#### Valuations Remained Grounded

Most of our holdings were trading near their **historical P/E averages**, leaving little room for derating. This discipline protected us when reality caught up with stretched valuations elsewhere.

#### Cash as a Strategic Lever

We aren’t compulsive investors. **Small caps are inherently volatile** — and we embrace that by staggering our entries to turn volatility into opportunity.

• Over the last 6 months, we held **nearly 60–70% of fresh inflows in cash**, which meaningfully cushioned the downside during the correction.  
• We also trimmed select positions to build **cash buffers for existing investors** — adding flexibility when it mattered most.  
• As the correction unfolded, we began **deploying this dry powder judiciously** into our highest-conviction ideas, taking advantage of attractive valuations.

## Separating the Wheat from the Chaff

> Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.
>
> Warren Buffett

## 02. Separating the Wheat from the Chaff

Small-cap companies can be exceptional wealth creators — but without the right filters, they can just as easily destroy capital. In fact, **7 out of 10 small-cap stocks tend to be value-destructive**, resulting in an industry-wide success rate of barely **30%**. The reasons are often structural: poor governance, opaque disclosures, promoter misalignment.

Stocks like **Gensol Engineering, AGS Transact, and Mishtann Foods** — once retail favourites — are now down **92%, 95%, and 75%** from their 52-week highs[2]. The headlines may cite volatility, but the real culprit is often a **deeper flaw in business quality or management intent**.

[Chart: Retail Favourites Turned Capital Destroyers. Drawdown from 52-week high through March 2025. Drawn on the web page: https://equitreecapital.com/insights/newsletters/march-2025#wheat-from-chaff]

Series: Drawdown from 52W high.

Source: TradingView price history[2].

> **Takeaway:** At Equitree, we’ve spent **over a decade** refining a process built not just to find winners — but to avoid the mistakes that can permanently destroy capital. With rigorous filters, on-ground diligence, and valuation discipline, we’ve delivered a **hit rate of over 85% since 2012**. In our view, the pain of backing the wrong business is far greater than the cost of missing the right one.

### 01. Stay Within Your Circle of Competence

Bull markets are tempting. Everyone wants to ride the **“next big thing”** — the next fintech, the next SaaS disruptor, the next EV platform. But complexity often masks mediocrity.

We consciously avoid sectors where we can’t confidently model earnings or understand the core drivers — such as **BFSI, direct real estate, and certain new-age business models**.

Another equally important (and underrated) skill is the **ability to filter out noise**. Every day brings a fresh idea from brokers, analysts, Telegram groups, or fellow investors. Over time, we’ve trained ourselves to pause — to **not act on anything until we’ve done the work ourselves and built independent conviction**.

### 02. Don’t Overpay for the Future

*Even the right story can be the wrong investment — if the price is wrong.*

We’ve seen this movie before. Earnings expected to grow at 30%, priced at 80×. Then one quarter disappoints and the rerating is brutal. These are precisely the setups we avoid — **hot narratives priced 2–3 years ahead of reality**. They often look expensive on current earnings and fragile on future ones. In small caps, obvious growth stories often disappoint the most. The industry may be right, but if the entry valuation isn’t, returns rarely follow.

Another example that comes to mind is a **cloud computing SME** — widely touted as **“India’s AWS”** — which gained popularity through finfluencers, WhatsApp forwards, and a fast-growing topline. Today, **Varanium Cloud Ltd is down ~98% from its peak**: from ₹374 (Jan 2023) to ₹6 (March 2025)[2]. The problem wasn’t technology. It was **valuation chasing vision with no earnings to anchor it**. We stayed away.

[Chart: Varanium Cloud Ltd — Down 98%. Weekly close, Sep 2022 – Mar 2025  |  ₹381.5 peak (13 Jan ’23) → ₹8.45 (24 Mar ’25). Drawn on the web page: https://equitreecapital.com/insights/newsletters/march-2025#wheat-from-chaff]

Series: Varanium Cloud.

Weekly closing price (last traded day of each week) from NSE daily end-of-day files, symbol CLOUD (NSE Emerge). Closes before the 12 May 2023 ex-date of the 1:1 bonus and ₹10 to ₹5 split are divided by 4, NSE’s adjustment factor. The stock rose about eleven-fold from ₹35.3 (30 Sep ’22) to a weekly-close peak of ₹381.5 on 13 Jan ’23 (₹400.6 intraday on 16 Jan), then gave back the move over the next two years. From mid-Feb 2025 it traded in NSE’s SZ series, so the last points are weekly rather than daily prints. Source: NSE end-of-day price data[2].

### 03. Incessant Dilutions Are Never Investor-Friendly

We are wary of companies that frequently raise funds via equity. Repeated fundraising typically signals that the company is **not generating enough internal accruals** to fund its own growth. When a business is perpetually dependent on external capital, it raises critical questions — not just about capital efficiency, but also about the **sustainability of its operating model**.

Even in situations where an equity raise is justified, **EPS accretion must remain a non-negotiable**. Growth financed by dilution is not true value creation unless it translates into per-share earnings expansion over time.

We recently studied a **hospitality company** that consistently raised equity across reporting periods. Over this period, **EPS CAGR was -4% (Mar ’21 to Dec ’24)**, even as the business kept raising capital. The dilution did not translate into profitability. For us, this is a red flag — not just for capital allocation, but for **governance, alignment, and long-term value creation**.

| Period | Promoter Holding |
| --- | :---: |
| Jun-22 | 74.31% |
| Jun-23 | 57.56% |
| Jun-24 | 45.97% |
| Feb-25 | 45.42% |

A hospitality company with high dilutions. Source: BSE filings; Equitree Research.

### 04. Promoter Behaviour Is the First Financial Statement

In small-cap companies, **promoter transactions often precede fundamentals**. A silent exit can say more than any earnings call. We monitor this very closely at Equitree.

We were invested in a **listed logistics company**. One quarter, we noticed that the promoter had sold just over 2% of their holding. While the number itself wasn’t alarming, there was **no change in equity share capital, and no accompanying explanation**. That made us uncomfortable — and we chose to exit.

Since then, the promoter has continued reducing their stake quietly. **Over nine quarters, their holding has declined by ~20% — from 73.71% (Jun ’22) to 57.10% (Mar ’25)** — all without any dilution. The share price continues to trade at the same levels.

[Chart: Promoter Holding — Logistics Company. Quarterly promoter stake (%), Jun ’22 – Mar ’25  |  73.71% → 57.10%, no equity dilution. Drawn on the web page: https://equitreecapital.com/insights/newsletters/march-2025#wheat-from-chaff]

Series: Promoter Holding.

Promoter and promoter-group holding as a % of total shares at each quarter-end, from the BSE shareholding-pattern filings. The 16.6 percentage-point decline came in steps between Jun ’22 and Dec ’23 (−2.6, −4.5, −2.0, 0.0, −2.8 and −4.7 points), after which the stake held at 57.10% through Mar ’25. The total number of shares outstanding did not change. Source: BSE shareholding filings[2].

> **Takeaway:** We’re not suggesting that every promoter sale is a red flag. But **large or consistent stake sales, especially when not explained clearly, must be scrutinised**. We also avoid companies with high promoter pledges, where any correction can trigger forced selling — often at the expense of public shareholders. *If the Promoter is not backing their business with conviction, why should we?*

### 05. Resignations at the Top

Governance issues rarely show up first in the financials. More often, they start with **resignations**. At Equitree, we track auditor exits, independent director resignations, and CXO churn as **early indicators of deeper problems**. One departure may be unrelated. But multiple exits in a short span — especially at senior levels — often signal underlying misalignment, operational strain, or governance concerns.

A recent example was a **newly listed auto OEM**, where **seven senior executives — including the CEO, CFO, CTO, and CMO — resigned within nine months**. Some left within weeks of joining, others moved to competitors. Around the same time, the company drew attention for subpar product quality and lacklustre after-sales service. We weren’t invested. And this only confirmed why. **The stock is down 60% since August 2024**[3].

**Ola Electric’s CXO resignations in CY2024**

- Apr 29: CEO (Cabs / Mobility)
- May 16: Group CFO
- Oct 1–10: VP Sales (Ola Electric)
- Oct 18: CBO (Ola Consumer)
- Nov 30: Service Head
- Dec 27 (1): CTO
- Dec 27 (2): CMO

Source: Public BSE / company filings. Seven senior departures across the CEO, CFO, CTO, and CMO offices over nine months in 2024[3].

### 06. Related Party Transactions

Some risks don’t show up in the income statement — they’re **buried in the footnotes**. Complex webs of related party transactions often blur the line between value creation and value diversion.

In one such instance, a promoter awarded himself a one-time **“value creation bonus” of ₹19 crore (2%)**, triggered simply because the value of the parent’s stake in a subsidiary increased post-IPO. There was **no operational milestone, no disclosed performance clause** — just a payout routed via a group entity. All technically compliant. But from a shareholder lens, **deeply misaligned**.

These are the kinds of structures we consciously avoid. We’re not against promoter rewards — but they should follow **real business delivery, not passive mark-to-market gains**. That’s not alignment. That’s leakage. It also sets a bad precedent for the future.

### 07. Tracking Promoters’ Interests Outside the Company

We invest in **family-run businesses**, but only when we’re confident that promoter bandwidth and incentives are **fully aligned with the listed entity**.

We recently evaluated a company **co-promoted by four families**, each of whom also ran their own unlisted businesses in the same industry. Structurally, it may have worked. But economically, it created a complex web — for us, and for any outside shareholder trying to make sense of where the promoter’s loyalties lay.

The related party disclosures were extensive but offered little real clarity. There were **frequent cross-transactions, overlapping operations, and blurred boundaries** between group entities. Value may have been created somewhere — but tracking where it accrued, and who it accrued to, was near impossible.

> **Takeaway:** **We passed.** Not because the business was bad, but because we couldn’t tell **who it was ultimately being run for**.

### 08. Succession Planning

Succession planning is a key filter for us. We prefer investing in companies where the **roadmap for leadership transition is clearly thought through** — and more importantly, where there are **no disputes within the promoter family**.

Family disputes and unclear succession have historically been among the **most destructive risks for long-term shareholders**. The numbers may look fine for a while, but when leadership falters, the damage tends to be sudden and steep.

We passed on a **well-established auto ancillary business** for this reason alone. The promoter’s son wasn’t interested in the company. The son-in-law, though operationally involved, **held no equity and had no real skin in the game**. The setup looked functional from the outside, but felt fragile once you scratched beneath the surface.

### 09. Reputation and Reference Checks

When it comes to promoter quality, **not everything shows up in the financials**. That’s why we routinely conduct **informal reference checks** through operators, suppliers, auditors, ex-employees, and industry peers — people who’ve seen the business up close and unfiltered.

**We meet the promoters multiple times before investing.** But we also make it a point to meet middle management — not just the face of the company, but the people who actually run it. These conversations often reveal more about culture, continuity, and internal dynamics than any investor deck.

We approach investing with an **ownership mindset**, which makes it critical to know who we’re backing. By leveraging our private equity network and industry scuttlebutt, we’re often able to steer clear of businesses that look good on paper — but raise questions on the ground.

In one instance, we visited a **hospital chain** where the promoter showed up with two armed bodyguards. He had recently produced a political biopic. The numbers were fine. The business had growth visibility. But the promoter’s presence told us enough to pass.

> **Takeaway:** We’d rather **miss a good business** than **partner with someone we don’t trust**.

### 10. On-Ground Checks: A Phone Call Can Save Your Portfolio

Before we invest, we go out and **test the story on the ground**. We don’t just rely on management commentary — we speak to **dealers, distributors, franchisees, and even customers**. It’s remarkable how much clarity a few calls can bring.

We also make it a point to **visit the company’s plants, factories, and key facilities** as part of our due diligence. It helps us assess not just the scale of operations, but the strength of the brand and its actual acceptance in the market.

In one case, we evaluated a **fitness chain** that appeared to be scaling rapidly. The reported numbers looked great. But when we called five of their **Tier 2 and Tier 3 outlets, not one picked up**. Online reviews were patchy. Front desk staff was untrained. The sales funnel, by every sign, was broken. The operating reality didn’t match the financial story. **We walked away.**

### 11. Financial Forensics

At Equitree, our research team — **all CAs and CFAs by training** — brings a forensic lens to every annual report. We track year-on-year changes in **receivables, inventory, depreciation policies, and cash flow conversion**, but we also watch for **inconsistencies** — like employee costs shrinking while revenues grow, or electricity expenses falling despite rising volumes.

In one case, a **dairy company** took a large inventory write-off while peers didn’t. Around the same time, **the CFO resigned without explanation**. Either event could’ve been overlooked. **Together, they told us to step away.**

We benchmark **tax paid vs. PBT**, scrutinise cash flow quality, and study footnotes year-on-year. It’s not about catching fraud — it’s about **recognising when something doesn’t feel right, before the market figures it out**.

## 03. Mistakes That Shaped Our Process

Some of our best filters were **forged in hindsight**. These are three mistakes we’ve lived through — and what they taught us.

### Leverage Is a Silent Killer

We once invested in an **agri-processing and equipment company** with a debt-to-equity ratio of over 2×. The business was growing, but working capital was stretched. When **receivables got delayed, the entire engine jammed**: bank repayments were missed, the company’s credit rating was downgraded to **“D”**, and promoter-pledged shares risked being liquidated by lenders.

We exited at a loss — not because of the business model, but because **our initial thesis broke and the balance sheet couldn’t take the stress**.

> **Takeaway:** In small caps, **balance sheet strength is non-negotiable**. Focus on businesses with **low D:E and low promoter pledge**.

### Untested Business Models Can Test You First

We once backed a **new-age company** positioned as a cash machine, thanks to its expected **negative working capital cycle**. That advantage, however, never materialised. The promoter began **experimenting mid-cycle** — adding new products, reworking the supply chain, chasing scale.

Inventory started building. Margins eroded. And by the time the dust settled, the business had turned **cash-negative and debt-heavy** — structurally compromising the balance sheet.

> **Takeaway:** We now favour **simplicity, consistency, and operating history of 2+ decades** over narratives and hype.

### Promoter Intent: The Final, Unforgiving Filter

We invested in a **global pharma company** with four USFDA-approved plants and a visible runway. But when a global private equity fund exited its quasi-equity investment, the promoter made a high-stakes call: instead of raising equity, **he replaced it with high-cost debt — purely to protect valuation**.

The bet backfired. **Debt service began to strain operations.** Eventually, the company had to **sell off core assets just to meet obligations** — leaving equity shareholders with nothing.

> **Takeaway:** Business quality means little **without promoter integrity**. We now place greater weight on **capital allocation and long-term alignment** than on operating credentials alone.

## 04. Market Outlook: Navigating Uncertainty with Conviction

The single most significant overhang in the current environment is the **uncertainty surrounding tariffs**. We are now in the midst of the **90-day pause window**[4], with multiple potential outcomes ahead. Attempting to forecast the trajectory — let alone the second- and third-order effects — would be speculative at best. **In such moments, restraint and readiness are more valuable than prediction.**

As bottom-up investors, our lens remains firmly on **fundamentals**. We’ve already assessed the direct impact of tariff-related disruptions on our portfolio companies, **stress-testing their resilience** in the event of a demand slowdown or margin compression. We shared a detailed note on this earlier and encourage investors to refer to it for specifics. As always, we’ll continue to track developments closely and respond with agility if required.

Having completed a thorough bottom-up review, we remain confident in our portfolio’s ability to weather near-term volatility. We expect our holdings to deliver approximately **30% earnings growth in FY26 (excluding any tariff impact)**, and the portfolio currently trades at a compelling **14.3× FY26E earnings**.

> **Takeaway:** In our view, the current environment offers a **rare opportunity for long-term investors**: quality businesses, clear earnings visibility, and compressed entry valuations. **As of March-end, we held 13.6% cash at the PMS level**, with individual investor cash levels varying based on entry timing. We’ve used the recent correction to **average deeper into core holdings — selectively, not hastily**.

We remain bullish on **India’s long-term structural story**. Short-term noise does not shake our conviction. If anything, it sharpens our focus.

Thank you, as always, for your continued trust. We remain steadfast in our commitment to navigating every phase of the cycle with **discipline, humility, and a long-term lens**.

For any feedback or queries, please feel free to [reach out to us](https://equitreecapital.com/contact).

Sincerely,

Team Equitree

- Pawan Bharaddia, Co-Founder & CIO (pawan.b@equitreecapital.com)
- Ssuneet Kabra, Co-Founder & CEO (skabra@equitreecapital.com)

## Sources

1. Nuvama Custodian Services; Equitree Capital internal performance and NAV records (March 31, 2025). Returns are TWRR, net of fees and expenses, and not verified by any regulatory authority/SEBI.
2. TradingView price history — Gensol Engineering, AGS Transact, Mishtann Foods, and Varanium Cloud Ltd, drawdown levels referenced from 52-week highs through March 2025.
3. Public BSE / company filings — Ola Electric Mobility CXO resignations and share-price drawdown from August 2024 to March 2025.
4. White House Trade Proclamation, April 2025 — Reciprocal-tariff order, 90-day pause announced April 9, 2025.

## Disclaimer

This newsletter is prepared by Equitree Capital for informational purposes only and is directed at existing investors of its Portfolio Management Services. It does not constitute investment advice, an offer, or a solicitation to buy or sell any securities.

Past performance is not indicative of future results. Returns are computed on a TWRR basis, net of fees and expenses, and are not verified by any regulatory authority. Individual portfolio performances may vary. Forward-looking statements are subject to risks and assumptions that may not materialise.

Investments in small- and micro-cap equities carry higher volatility, liquidity, and business-specific risks, including the possible loss of principal. Equitree Capital is a SEBI-registered Portfolio Manager. Recipients should consult their independent financial, legal, and tax advisors before making any investment decisions.

This document is private and confidential. It may not be reproduced, redistributed, or published, in whole or in part, without the prior written consent of Equitree Capital.