The BSE Smallcap Index has jumped 21% in just three months, comfortably outpacing the Nifty’s 12% gain in the same period. Several individual names have delivered astonishing returns — NACL Industries has soared 192%, while Garden Reach Shipbuilders (GRSE) is up 147%. Stocks like Suven Life, Centum Electronics, Cosmo First, Bharat Dynamics, Zen Tech, and Mangalore Chemicals have either doubled or come close.
The smallcap momentum is unmistakable and it’s being powered by both macro conditions and strong flows, just like what Dalal Street saw in 2024.
“We firmly believe that over the long-term in a growth economy like India, smallcap stocks could outperform largecaps,” said Venugopal Manghat, CIO – Equity at HSBC Mutual Fund. “Smaller companies tend to thrive in expanding economic cycles leading to higher earnings growth. The environment is conducive — low inflation, falling interest rates, improving liquidity and strong tailwinds in manufacturing, infrastructure and financialization.”
A mix of economic recovery, liquidity inflows and earnings optimism is fuelling the rally. But alongside the euphoria, voices of caution are growing louder.
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“Despite the sharp upmove recently, largecaps currently offer a better balance of earnings visibility and valuation comfort on a forward-looking basis,” warned Krishna Appala, Fund Manager at Capitalmind PMS. “The divergence between earnings and valuations in the broader market calls for greater selectivity. The environment today rewards fundamentals and discipline over broad-based exposure — especially when mid and smallcap multiples leave little room for error.”
Indeed, valuations are no longer cheap. Trideep Bhattacharya of Edelweiss estimates that “mid and small caps are trading at a 17% to 25% premium to their 10-year averages.” He emphasizes the importance of being selective: “We advise that where there is a valuation premium, it must be matched with an earnings growth premium. Stocks with faltering growth but high valuations are in the penalty box.”
Bhattacharya also advocates tailoring investment strategy to individual risk appetites: “For conservative investors, we recommend flexicap funds. For moderate risk-takers, multicap funds. And for those with higher risk appetite and a 5–10 year horizon, midcap funds are ideal.”
Fundamentals are showing signs of support. Some sectors posted better-than-expected numbers in the March quarter. “There were a few pockets where Q4 results exceeded expectations,” said Sneha Poddar of Motilal Oswal. “Raw material prices remained stable, global demand was supportive, and FMCG companies managed weaker urban demand with price hikes. Overall, demand wasn’t as weak as feared.”
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Still, market veterans warn that the easy money may already be made. After a relentless three-month rally, the risks of overpaying in the smallcap space are rising, particularly in stocks where future earnings may not live up to the newly inflated prices.
The real test now lies in sustainability. Will earnings keep pace with valuations? Will global liquidity remain supportive? And perhaps most importantly, will investors stay disciplined when the next correction hits?
“The divergence between earnings and valuations in the broader market calls for greater selectivity. The environment today rewards fundamentals and discipline over broad-based exposure — especially when mid and smallcap multiples leave little room for error,” Apala said.
For now, the fireworks in smallcaps are lighting up investor portfolios. But those looking to join the party now may need to tread carefully. In this market, growth and discipline, not just price charts, will separate the winners from the rest.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
