BSE Midcap, Smallcap indices up 21% each in less than 3 months; what should investors do? Here's what experts say

Since November last year, the domestic market has been witnessing robust gains, propelled by impressive domestic macroeconomic indicators, expectations of political stability following the General Elections, and the anticipation of interest rate cuts by the US Fed and the RBI this year. Although the benchmark indices the Sensex and the Nifty 50 have registered substantial double digit growth in the last two and a half months, the remarkable outperformance of mid and small cap indices is noteworthy.

This exceptional performance stands out even in the face of growing apprehensions about their valuations. Since November 2023, the Sensex and the Nifty 50 have jumped 14 per cent and 15 per cent respectively while the Midcap and Smallcap indices have jumped 21 per cent each. Some small cap stocks such as Gallantt Ispat, GTL Infrastructure, Kesoram Industries, Inox Green, Wockhardt, Praveg, Inox Wind and Navkar Corporation have jumped over 100 per cent since November.

In the midcap space, stocks such as HPCL, Power Fin Corp, BHEL, GlaxoSmithKline Pharmaceuticals, IRFC, , New India Assurance Company, GMR Airports and have jumped over 50 per cent each in the same period. Also Read: Why are midcaps and small caps rising? Experts observe that mid and small cap stocks have been witnessing strong interest from retail investors as they exhibited notable earnings growth.

Moreover, investors looking for high growth opportunities are lapping up these stocks. Shrey Jain, Founder and CEO of SAS Online pointed out that after a spectacular show in the calendar year 2023 (CY23), investors’ interest has gone up in mid and small cap stocks. "Investors looking for high growth opportunities are lapping up these stocks.

A look at net inflows in equity mutual funds makes it amply clear that individuals investing through mutual funds have also preferred small cap and mid cap schemes over large cap schemes. For example, in December 2023, small cap schemes and mid cap schemes received net inflows of 3,857 crore and 1,393 crore respectively, compared with a net outflow of 280 crore from large cap schemes.

Investors lack appetite for large cap stocks whereas there is a clear preference for mid and small cap stocks," said Jain. During periods of economic growth, mid and small cap stocks often exhibit accelerated growth, presenting lucrative opportunities for investors. India's macroeconomic condition remains robust, further enhancing the appeal of these stocks.

Additionally, the commendable quarterly earnings reported by numerous mid and small cap companies underscored their substantial growth potential, drawing the interest of retail investors seeking profit. Vinod Nair, Head of Research at Geojit Financial Services pointed out that several industries within the mid and small cap categories exhibit notable earnings growth.

"Q2 data reveals a 25 per cent year on year (YoY) growth in the Nifty100 index's adjusted PAT, while mid and small cap indices recorded a higher growth of over 35 per cent," Nair observed. Also Read: What should investors do? Many experts feel that the small and midcaps could underperform the Nifty 50 this year.

However, Deepak Jasani, Head of Retail Research at HDFC Securities thinks otherwise. "While some experts feel that the small and midcaps could underperform the Nifty going forward, we think that there would be months or quarters where the Nifty may do better than the mid and small caps but on an overall basis, the broader market may still do well," said Jasani.

"Small and Midcap space is where one can hope to gain alpha. The valuations of mid and small cap indices are higher than the Nifty 50. This may be because these indices may include some loss, small profit making companies and also the growth rate in earnings overall is faster than that in the Nifty 50.

Lower float value and lower institutional participation/holding in the small and midcap space may also be the reason for higher valuations in these spaces," Jasani pointed out. "While valuation on an overall basis seems stretched in mid and small cap indices, investors will have to be selective and prune holdings in stocks that have run up far beyond the valuations based on FY26 or FY27 earnings," said Jasani.

Nair underscored that India has been on the cusp of a strong rally in the last three months. This is the culmination of a pre election rally and an improvement in the global market due to a moderation in risk led by a falling bond yield. However, sustained outperformance of mid and small caps has instilled the risk of overvaluation and overbought scenarios in the short to medium term.

"Adopting a rational investment approach, investors should secure profits by reallocating funds to large caps, which present a more lucrative prospect for long term gains," said Nair. Also Read: Jain said investors have to be selective with their investments in mid and small cap stocks. "Some of these companies may be quoting far ahead of the underlying value.

Avoid chasing stocks moving up fast after an announcement of an expansion plan. Investors need to keep track of execution rather than focusing on mere announcements," said Jain. "It is better to back companies with solid balance sheets, a track record for earnings growth and capable promoter.

Traders need to have a trailing stop loss. Profits booked in the mid and small cap stocks can be ploughed back into good quality large cap stocks," Jain said. Read all market related news Livemint tops charts as the fastest growing news website in the world to know more. Unlock a world of Benefits! From insightful newsletters to real time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away!.