LS Polls: Correction in mid, smallcap stocks may not be over, warn analysts

Mid, small-cap stocks in focus: The Indian stock markets took a heavy beating on Tuesday as the 2024 Lok Sabha election result showed the ruling Bharatiya Janata Party (BJP) falling short of a clear majority.

On the bourses, the benchmark BSE Sensex, and NSE Nifty50 fell nearly 6 per cent each, while the broader Mid, SmallCap indices crashed up to 8 per cent.

Among individual stocks, REC plunged approximately 20 per cent while IRCTC dropped over 13 per cent.

Going ahead, analysts see more pain in the offing for broader markets as stocks command extremely rich valuations, limiting upside in the near-term.

According to Deepak Jasani, head of retail research at HDFC Securities, the broader markets appear to be overvalued, despite Tuesday's correction, indicating the possibility of further downward movement.

While Nifty commands a price to earnings (P/E) valuations of around 18.7x FY26, it still doesn't offer much upside for ~12 per cent earnings CAGR over FY24-26. The Nifty mid/ small-cap indices, meanwhile, are trading at 29x/18x versus their 10-year long-term average of 21x/16x, respectively.

As Mid and small-cap indices trade at a premium to the Nifty, analysts expect the broader market to remain under pressure in the near-term.

"Investors are advised to stay away from small, micro-ap stocks as there will, likely, be more corrections in the near-term," said Gaurav Dua, SVP, Head - Capital Market Strategy, Sharekhan by BNP Paribas.

Lok Sabha results
 

Indian stock markets investors were left stunned on Tuesday after the INDIA Alliance bagged 234 seats, surpassing exit polls estimates.

The National Democratic Alliance (NDA), meanwhile, secured 292 seats, with the BJP winning 240 seats out of the 543-member Lok Sabha.

As the BJP lacked a clear majority, India is set to have a coalition government after 10 years. This, analysts said, may lead to policy uncertainty as decision-making or further reform push could slow and policy priorities might shift in the near term.

They, thus, advise investors, who are fully invested in equities, to exercise patience. For those who are not fully invested, analysts recommend opting for Systematic Investment Plans (SIPs) to target mid and small-cap stocks.

Investment strategy

From an investment stand-point, analysts expect volatility to remain the order of the day for the broader markets as the market will require some time to digest the unexpected election outcome.

A major market rebound, they said, seems improbable in the short-term, and there may be shifts in sectoral preferences.

"Investors should focus on sectors with relative margin of safety such as PSU banks, pharmaceutical and healthcare, and FMCG due to their attractive valuations at current levels," said Vinit Bolinjkar, head of research at Ventura Securities.

Potential rate cuts, along with the new government's focus on rural recovery, could stimulate consumption, boosting the outlook for FMCG stocks, he added.

Deepak Jasani of HDFC Securities, too, picked Financials, including private and public banks, and FMCG as his favourable investment bets at present.

"After the initial disappointment and anxiety around government formation, we expect the focus to revert to fundamental bottom-up stock picking. That said, sectors with over-heated valuations and recent sharp outperformance viz. Industrials, Railways, Defence, and PSUs may see more moderation in valuations before they become attractive again from the risk-reward perspective," said those at Motilal Oswal Financial Services.